Case Western Reserve Law Review
Volume 32 | Issue 1
1981
Estate Planning and the Generation-Skipping
Transfer Tax
Harold G. Wren
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Harold G. Wren, Estate Planning and the Generation-Skipping Transfer Tax, 32 Cas. W. Res. L. Rev. 105 (1981)
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Estate Planning and the
Generation-Skipping Transfer
Tax
Harold G. Wren*
Although the generation-skoppingtransfer tax (GS7T) survived the Economic Recovery Tax Act of 1981, many changes have resultedfor the estateplanner. In his
Article, Professor Wren examines the GS7T and analyzes the effect of these new
changes on that tax. Utilizing the new rules and the GST, Professor Wren concludes with useful examplesfor the estateplanner on how to obtain maximum tax
andnontax beneits.
INTRODUCTION
1
THE Economic Recovery Tax Act of 1981 (ERTA) introduced
several new concepts in estate planning. Although the act expanded the unified credit to provide for a $600,000 exemption
equivalent by 1987,2 increased the annual gift tax exclusion from
$3,000 to $10,000, 3 and introduced the unlimited marital deduction, 4 it did not repeal the generation-skipping transfer tax
* Professor of Law, University of Louisville and Distinguished Visiting Professor of
Law, Case Western Reserve University School of Law, 1981-1982. A.B., Columbia University (1942); LL.B., Columbia University (1948); J.S.D., Yale University (1957).
1. Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, 95 Stat. 172 (to be codified at scattered sections of 26 U.S.C.A.).
2. ERTA § 401 (amending I.R.C. §§ 2010 (a), (b) (relating to unified credit against
estate tax after Dec. 31, 1976), 2505(a), (b) (relating to unified credit against gift tax after
Dec. 31, 1976), and 6810(a) (relating to estate tax returns by executors after Dec. 31, 1976)).
The unified credit and the corresponding exemption equivalents for 1981 through 1987 are:
Unified Credit
Exemption Equivalent
1981
$ 47,000
$175,800
1982
62,800
225,000
1983
79,300
275,000
1984
96,300
325,000
1985
121,800
400,000
1986
155,800
500,000
1987 and all
192,800
600,000
subsequent years
3. ERTA § 441 (amending I.R.C. § 2503 (relating to taxable gifts)).
4. ERTA § 403 (amending I.R.C. §§ 2056 (relating to estate tax deduction), 2523
(relating to gift tax deduction)).
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
(GSTT).5 Today's estate planner must be prepared, therefore, to
create an estate plan that takes advantage of the new rules and
simultaneously plans for the ultimate incidence of the GSTT
While only three out of one thousand estates may be subject to
the federal estate tax under the new law,' planning is still essential
to obtain the maximum tax and nontax benefits for clients. Indeed, ERTA has created an unprecedented degree of flexibility in
estate planning. This Article reviews the GSTT as developed in
the Internal Revenue Code (the Code) and the Proposed Treasury
Regulations (the regulations) and offers the estate planner tools to
aid in integrating the new rules into an overall estate plan. To
achieve this objective, this Article examines the GSTT in detail,8
explores the new tools provided to the planner, 9 and suggests
methods that best integrate these tools into the optimal estate
plan.
l°
5. Although the GSTT was not repealed, the effective date for the "grandfathering"
of existing trusts was extended from January 1, 1982 until January 1, 1983. ERTA § 428
(amending the Tax Reform Act of 1976 § 2006(c), 26 U.S.C. § 2601 (1976), as amendedby
Revenue Act of 1978, Pub. L. No. 95-600, § 702(n)(1), 92 Stat. 2763, 2935 (1978), and
Technical Corrections Act of 1979, Pub. L. No. 96-222, § 107(a)(2)(B), 94 Stat. 194, 223
(1980)). The following trusts are considered to be "grandfathered" and excluded from the
GSTT: (1) a trust that was irrevocable on June 11, 1976, to the extent that the transfer is
not made out of principal added to the trust after June 11, 1976; (2) any revocable trust
created before June 12, 1976, which was not amended by the decedent at any time after
that date to create or increase any generation-skipping transfer prior to decedent's death on
or before December 31, 1982; and (3) any testamentary trust arising from a will executed
prior to June 12, 1976, when the testator dies before January 1, 1983, provided there has
been no addition to the trust, due to execution of a codicil or for some other reason which
would create or increase any generation-skipping transfer. If a decedent were unable to
change the disposition of his or her property on June 11, 1976 due to a mental disability,
the period for (2) and (3) above is extended until two years after the decedent has regained
competence to dispose of the property. Id.
6. The GSTT has been criticized as being "entirely too complex and... virtually
unworkable from an administrative standpoint." 7 Am. College of Probate Counsel, Probate Notes No. 4, at I1 (Summer 1981). Some predict that "Congress won't get rid of the
tax entirely, [but] it will be simplified to make it more workable." PRtFncE-HALL, INC.,
HANDBOOK ON THE ECONOMIC RECOVERY TAX ACT OF 1981 179 (1981). The College
also has stated that the GSTT "creates other inequalities and injustices" and produces an
"administrative nightmare." 8 Am. College of Probate Counsel, Probate Notes No. 4, at
34-35 (Winter 1982).
7. N.Y. Times, Sept. 21, 1981, § A, at 24, col. 1 (editorial). Congressman Al Ullman,
former Chairman of the House Ways and Means Committee, questioned this editorial in a
letter to the N.Y. Times, emphasizing that there still would be many large estates subject to
transfer taxes. Id., Oct. 5, 1981, § A, at 20, col. 6.
8. See infra notes 23-50 and accompanying text.
9. See infra notes 51-261 and accompanying text.
10. See infra notes 17-20 & 267-85 and accompanying text.
ESTATE PLANNING
19811
I.
THE POLICY BEHIND TRANSFER TAXATION
The concepts of the GSTT and the unlimited marital deduction provided by ERTA originated in the basic principle governing all transfer taxation: that accumulations of wealth within a
family unit should be taxed only once in each generation.". Since
husband and wife are deemed to be of the same generation,"
there should be no tax on any transfers between them. As property passes from their generation to each succeeding one, however,
the transfer tax should be imposed, with such specific exemptions
as legislative policy may dictate. 13 If the principle of transfer tax-
ation with respect to accumulations of wealth is to be retained, 14
the continued existence of both the GSTT and the unlimited mari-
tal deduction are essential. Alternatively, the entire system of
transfer taxation could be abolished 5 and the relative Tsmall loss
in revenue offset by a minor change in the income tax rates or
even through institution of a new tax, such as the value-added
tax.' 6 The purpose of this Article is not to debate the policies underlying transfer taxation, but to aid estate planners in their efforts
to accommodate the new rules of ERTA to the existing GSTT.
11. "[Ihe proposal [for an unlimited marital deduction] is designed to provide that
property of a married couple will be taxed once as it passes to the next generation, not
twice." U.S. DEP'T OF TREASURY, TAX REFORM STUDIES AND PROPOSALS 360 (1969).
"The basic objective of the proposal [for a GSTT] is to obtain a transfer tax with respect to
each generation regardless of whether that generation receives the property or is skipped in
favor of a succeeding generation." Id. at 389.
12. I.R.C. § 2611(6)(2) (1976).
13. See, ag., id. § 2613(b)(6) which provides for a $250,000 exemption per deemed
transferor (as defined in id. § 2612 (1976)) for transfers to the grandchildren of the grantor.
See infra notes 144-51 and accompanying text.
14. Legislation to repeal the GSTT has been introduced by Senator Steve Symms (R.
Idaho). Hearings on tie bill (S. 1695) are being scheduled before a subcommittee of the
Senate Finance Committee. Senator Symms describes the GSTT as "so complex that even
the most knowledgeable individuals or corporate fiduciaries, insurance people, accountants, and attorneys, all of whom are affected by this tax, are finding it extremely difficult to
interpret and apply." American Bankers Association, Trust Division, Trust Letter No. 185,
at 4 (Oct. 26, 1981) [hereinafter cited as Trust Letter].
15. The GSTT, with some modifications, might become the basis for a single transfer
tax system, making the estate and gift taxes unnecessary. Another alternative would be the
adoption of an accessions tax in lieu of the present transfer tax system.
16. Lester C. Thurow has suggested that a seven and one-half percent value-added
tax, with a $1,000 income credit, would raise about $95 billion in additional revenue.
NEwswEEK, Sept. 21, 1981, at 38. This amount is approximately 13 times the estimated $7
billion received in estate taxes each year. N.Y. Times, Sept. 21, 1981, at 20 (editorial). The
N.Y. Times notes that, "[b]y 1987, only three estates in a thousand will pay Federal [transfer] taxes, vastly fewer than before," and urges that "defects [in the system] could have
been repaired without abandoning the principle of wealth taxation altogether." Id. § A, at
24, col 1.
CASE WESTERN RESERVE LAW REVIEW
II.
PLANNING UNDER THE
GSTT
AND
[Vol. 32:105
ERTA
Under existing law, the GSTT does not guarantee that every
estate otherwise taxable will be taxed in every generation. It is
possible for the settlor to transfer property in trust for beneficiaries
of the same generation. A settlor, for example, can create one
trust for children, another for grandchildren, and another for
greatgrandchildren. Although the tax is avoided under this
scheme, such an estate plan may ignore the totally the client's
nontax objectives. ERTA, however, provides the planner with
many more options than under the old Code, thereby allowing for
the development of estate plans to serve such nontax objectives.
Prior to the unlimited marital deduction, for example, the planner
typically would give the surviving spouse complete control of fifty
percent of the adjusted gross estate to assure the greatest possible
marital deduction.' 7 Under ERTA, the planner can provide for
the complete retention or complete transfer of control by S1,18 depending on the nontax objectives S, and S2 19 seek.2 °
Many questions arise in the preparation of a family's estate
plan under the present law. The estate planner must determine
whether one basic trust for all members of the settlor's family
should be established, or whether it is preferable to establish separate trusts for each descendant or succeeding generation. The
planner also must decide how to relate the unlimited marital deduction to the trust or trusts established under the GSTT. One
alternative is that the familiar marital and nonmarital trusts can
be used to absorb one-half of the federal estate tax upon S,'s death
and the balance upon S2's death. Another alternative is that the
executor can be given the opportunity to elect to have the tax deferred under the new "qualified terminable interest rules." A
third alternative lies in giving the entire estate to S2 , thereby qualifying it for deferring the estate tax until S2's death. If a family
trust is already in existence, the planner must decide whether to
17. I.R.C. § 2056(c)(1)(A)(ii) (1976).
18. Throughout this Article, "S," will designate the spouse who is the first to die, and
also the one who has the bulk of the family's wealth.
19. "S2" will designate the surviving spouse, who owns little or no property individually. In community property states, of course, S, and S2 normally own 50% percent each of
the family's wealth, and for purposes of the marital deduction it would be immaterial who
died first.
20. See ERTA § 403(d)(1) (adding § 2056(b)(7) to the code and introducing Qualified
Terminable Interest Trusts (Q-TIP's)). Q-TIP's allow a grantor to maintain greater control
over the disposition of property without adverse tax consequences. The acronym, Q-TIP, is
derived from "qualified terminable interest in property."
19811
ESTATE PLANNING
create a new trust, or whether to merely add property to an existing trust. If a new trust is favored, it must be determined
whether both S1 and S2 should participate in its creation. The estate planner also must determine whether a trust should be created at all, or whether some "trust equivalent" should be utilized
instead.
Regarding taxation, the planner must decide how the transfer
tax should be planned in light of the increased unified credit at
both Sl's death and, subsequently, at S2's death; how the increased
gift exclusion of $10,000 per year per donee can best be coordinated with the GSTT; the extent to which joint interests should be
used; and whether, if faced with imminent dissolution of the family, the typical pre-1981 divorce and property settlement should be
used, or whether the plan should center around the unlimited
marital deduction. These are just a few questions planners must
consider while developing an estate plan that will accommodate
present planning for the GSTT to the more familiar estate planning concepts of the past. Before addressing these questions, an
analysis of the GSTT is necessary to identify new considerations
in developing estate plans.
III.
THE BASIC STRUCTURE OF THE
GSTT
To better understand the structure of the GSTT, several important terms must be defined. The GSTT is imposed on taxable
distributions and taxable terminations of a generation-skipping
trust (GST) or trust equivalent. A generation-skipping trust is an
instrument which assigns younger generation beneficiaries
(YGB's) to more than one generation.2 1 A YGB is a beneficiary
22
assigned to a generation younger than the grantor's generation.
A beneficiary is a person having a present or future interest or
power in a trust. 3 An interest in a trust is the right to receive
income or corpus or the permissible receipt of the income or
corpus from the trust.24 A power in a trust is any power to establish or alter the beneficial enjoyment of the income or corpus of
the trust.25
The statute provides several exceptions which prevent some of
these definitions from operating in special situations. A cautious
21. I.R.C. § 2611(b) (1976).
22. Id. § 2613(c)(1).
23. Id. § 2613(c)(3).
24. Id. § 2613(d).
25. Id §2613(d)(2).
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
planner, therefore, must retrace each of these definitions through
each section of the Code. An example illustrates the point.
Grantor, G, transfers property in trust to child, C, for life, remainder to G's grandchild, GC. This transfer is a GST. The trust
has two YGB's assigned to more than one generation younger
than G's. C and GC are both beneficiaries, since they each have
an interest in the trust. The fact that S's interest is apresent interest and GC's interest is afuture interest is irrelevant in determining whether the trust is a GST. The difference in interests is
relevant in determining the existence of a taxable distribution or
taxable termination.2 6
Whether a trust is a GST is determined immediately before
the transfer.2 7 In this respect, the GSTT is similar to the common
law rule against perpetuities.2 s The planner should be concerned
with what may happen in the future and not only with what actually occurs.
A. Assignment of Generations
Since a GST is defined in terms of YGB's assigned to more
than one generation younger than the grantor's generation, the
method of ascertaining generations is critical. The proposed regulations29 state the rules in terms of related and unrelated persons.
In addition, these rules state special rules dealing with: (1) the effect of marriage or adoption; (2) multiple generation assignments;
(3) treatment of half-bloods; and (4) entities as beneficiaries.
1. Related Persons
The lineal descendants of a grantor's grandparent 30 are assigned to a generation based on the difference between the
number of generations between the grandparent and the individual to be assigned and the number of generations between the
26. See infra notes 118-31 and accompanying text.
27. I.R.C. § 2613(c)(2) (1976).
28. See, e.g., KY. REV. STAT. ANN. § 381.216 (Baldwin 1969); 20 PA. CONS. STAT.
ANN. § 6104 (Purdon 1975 & Supp. 1981). For a brief but excellent description of the rule
against perpetuities, see T. BERGIN & P. HASKELL, PREFACE TO ESTATES IN LAND AND
FUTURE INTERESTS 183 (1966).
29. The proposed regulations for the GSTT were promulgated by the Commissioner
of Internal Revenue in the last days of President Carter's administration. 46 Fed. Reg. 120
(1981).
30. This group includes the lineal decendants of the grantor, plus his or her parents
and collateral relatives within the grandparent's parentela, such as first cousins and grandnephews. The Uniform Probate Code uses the same standard to determine the extent of an
intestate's heirs. See UNIF. PROBATE CODE § 2-103 (1977).
ESTATE PLANNING
grandparent and the grantor, the latter number always being
two.31 A grandnephew, for example, would befour generations
removed from the grandparent of the grantor and would be assigned to two generations (4-2=2) youiger than that of the
grantor.
2. UnrelatedPersons
Calculating the generation of one who is neither married nor
related to the grantor is a simpler process. The proposed regulations track the statute and calculate the relationship to the grantor
mathematically. An individual born not more than twelve and
one-half years after the birth of the grantor is assigned to the grantor's generation. An individual born more than twelve and onehalf years but less than thirty-seven and one-half years after the
birth of the grantor is assigned to the first generation younger than
Similar rules apply for a new generation every 25
the grantor.
32
years.
3. Effect of Marriage or Adoption
A person who has atany time been married to the grantor or to
a beneficiary is assigned automatically to that grantor's or beneficiary's generation.33 In addition, a relationship created by legal
adoption is treated as a blood relationship.3 4 Since marriage and
adoption are legal relationships that can be entered into voluntarily by either the grantor or any beneficiary, these rules effectively
give the planner some control over changes in generations,35provided the marriages or adoptions involve unrelatedpersons.
4. Multple GenerationAssignment
The proposed regulations repeat the statutory rule that an individual assignable to more than one generation shall be assigned
to the youngest generation. 36 These regulations then add that
31. I.R.C.
§ 2611(c)(1) (1976).
32. Id. Prop. Treas. Reg. § 26.2611-3(b), 46 Fed. Reg. at 122 (1981). Throughout this
Article, all cites to the proposed treasury regulations are from the 1981 edition of the Federal Register.
33. I.R.C. § 2611(c)(2) (1976); Prop. Treas. Reg. § 26.2611-3(a), 46 Fed. Reg. at 122.
34. I.R.C. § 2611(c)(4) (1976); Prop. Treas. Reg. § 26.2611-3(a), 46 Fed. Reg. at 122.
35. Although the statute does not specifically preclude marriage to, or adoption of, a
relatedperson, the determination of generations in these cases is subject to different rules
from those involving unrelated persons in order to prevent tax avoidance. Prop. Treas.
Reg. § 26.2611-3(c), 46 Fed. Reg. at 122. See infra note 37 and accompanying text.
36. I.R.C. § 2611(c)(6) (1976); Prop. Treas. Reg. § 26.2611-3(c), 46 Fed. Reg. at 122.
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
"[tihis rule does not apply to the adoption of an unrelatedperson
by the grantor or any beneficiary, or the marriage of an unrelated
person to the grantor or any beneficiary. ' 37 This language suggests three corollary rules. First, multiple generation assignment
will apply when the parties are related. Otherwise, the grantor or
beneficiary could, by marriage or adoption, move a YGB up one
or more generations. Second, multiple generation assignment applies when the grantor or beneficiary, or two beneficiaries, are unrelated. Absent marriage or adoption which causes the parties to
38
be related, however, the mathematical rule for unrelated persons
makes it difficult to see how a person could be assigned to more
than one generation. Third, when the parties are not related, one
party may change the generation assignment of another through
marriage or adoption.
A person also can be related to another in more than one fashion. Every grantor has at least four grandparents. Since the statute is based on lineal descent from any one of these four
grandparents, there will be times when a beneficiary may be related to the grantor through two different grandparents' parentelas. An example illustrates the point:
G, grantor, had a father, F, and a mother, M. F's father (G's
grandfather), GF, had two children, G's father, F, and U, G's uncle. U had one child, C, G's first cousin. M's mother (G's grandmother), GM, had two children, G's mother, M, and G's aunt, A.
A had a child (first cousin of G), X, who had a child, X-1. X-1 is
related to G as a first cousin, once removed. C married X-l, and
the couple had a child, X-2. X-2 would be related to G through
G's maternal grandmother as a first cousin, twice removed, but
through G's parental grandfather as a first cousin, once removed.3 9 In this case, the'Code 4° indicates that X-2 is treated as
37. Prop. Treas. Reg. § 26.2611-3(c), 46 Fed. Reg. at 122 (emphasis added).
38. See supra note 32 and accompanying text,
39. The relationship may be diagrammed as follows:
GF
I I
GM
I
I
1st Generation
U
F+
I
I
2nd Generation
C
G
X
3rd Generation
4th Generation
40. I.R.C. § 2611(c)(6) (1976).
I
""-.-
-Marr.age ....
""
X-2
X-I
19811
ESTATE PLANNING
being in the fourth generation from GM and second from G,
rather than the third generation from GF and first from G.
If husband and wife join in the creation of a trust, as is the
norm in community property states, at least eight grandparents
may be involved. If the grantor's grandparents and parents remarry, the number of lineal descendants from a single grandparent of the grantor or grantors may become legion. The possibility
of the grantor's being related to a YGB through more than one
grandparent, therefore, is not so unusual.
5. Treatment of HalfBloods
Both the proposed regulations and the Code contain the rule
that "[a] relationship by the half blood shall be treated as a relationship by the whole blood."'" Since such a relationship hardly
can be controlled by a grantor or beneficiary, the rule does little to
affect the incidence of the tax.
6. Entity as Benoqciary
The proposed regulations do not add much to the Code rule
that the law looks through the entity beneficiary to determine the
actual beneficiaries and assigns them to generations according to
the rules governing individuals.4 2 The regulations state that an
"entity is not assigned to a generation,"4 3 and that a legatee or
heir of an estate, trust beneficiary, partner in a partnership, or corporate shareholder will be deemed to have an "indirect interest or
power."' The regulations also provide guidelines to determine
who has a present interest or power4" and who is a transferee
under the rules governing taxable distributions and taxable
terminations.4 6
The regulations list three examples demonstrating the operation of the ascertainment of generations. The first two examples
concern lineal descendants47 and unrelated persons, 4 and add lit41. Id. § 261 1(c)(3); Prop. Treas. Reg. § 26.2611-3(a), 46 Fed. Reg. at 122.
42. I.R.C. § 2611(c)(7) (1976); Prop. Treas. Reg. § 26.2611-3(d), (e), 46 Fed. Reg. at
122.
43. Prop. Treas. Reg. § 26.2611-3(d), 46 Fed. Reg. at 122 (excluding charitable corporations and trusts).
44. Id.
45. Id. § 26.2613-(4)(d), 46 Fed. Reg. at 128. See infra notes 186-225 and accompany-
ing text.
46.
170-85
47.
48.
Prop. Treas. Reg. § 26.2612-1(b), -3(a), 46 Fed. Reg. at 123, 126. See infra notes
and accompanying text.
Id. § 26.2611-3(f), example (1), 46 Fed. Reg. at 122.
Id., example (2).
CASE WESTERN RESERVE LAW REVIEW
[
[Vol.
32:105
tle to the Code definitions previously discussed. 49 The third example involves the separation of short term trust income from a
reversion retained by the grantor:
Assume A creates a short term trust for his child B for 11 years,
and that during the term of the trust A dies and leaves his entire estate to B's grandchild D. Since the estate has the unrestricted right to receive the income or corpus of the trust upon
the expiration of the 11 years, D is treated as a beneficiary of
the short term trust
and is assigned to the third generation be50
low the grantor.
The example is troublesome because A dies during the term of the
trust. Had A lived beyond 11 years, the property would have reverted to him in fee. Upon reversion, A might have made a gift of
the fee or bequeathed his entire estate to D. Obviously, such a gift
would not involve a GST. Although it seems that the grantor's
death during the term of the trust should not cause an amalgamation of B's income interest with D's interest under A's will, so as to
create a GST, the regulations appear to extend the scope of the
GSTT to cover this situation.
B.
GST Equivalent
The GSTT is imposed on GST's and their "equivalents." The
statute defines a GST equivalent as any nontrust arrangement
which has "substantially the same effect" as a GST. 11 Examples of
this concept include "life estates and remainders, estates for years,
insurance and annuities, and split interests."5 " The regulations repeat these examples and add "direct and indirect transfers to a
minor."5 3 More importantly, the regulations provide a comprehensive definition to cover any possible arrangements that might
have the effect of a GST. The regulations define a GST
equivalent as:
any legally enforceable arrangement whether effectuated by
contract, deed, will, agreement, understanding, plan or by any
other means (including any combination of the preceding at the
same or different times) which splits the beneficial enjoyment of
assets among two or more younger generation beneficiaries
49. See supra notes 29-32 and accompanying text.
50. Prop. Treas. Reg. § 26.2611-3(f), example (3), 46 Fed. Reg. at 122.
The value of A's reversionary interest would be includable in his gross estate under I.R.C.
§ 2031 (1976).
51. I.R.C. § 2611(d)(1) (1976).
52. Id. § 2611 (d)(2).
53. Prop. Treas. Reg. § 26.2611-4(a), 46 Fed. Reg. at 122.
ESTATE PLANNING
who are assigned to more than one generation. The characteri-
zation of any arrangement as a generation-skipping trust
and not on
equivalent depends on
54 the effect of the arrangement
the settlor's motives.
The Commissioner illustrates the GST equivalent rule with a
series of examples which reflect the commissioner's preventive approach to tax avoidance. The first example outlines the familiar
situation where an insured directs that the proceeds of a life insurance policy be left with the insurance company to pay the income
to child, C, for life, remainder to grandchild, GC. 51 Such an ar-
rangement is the equivalent of a GST. Suppose, however, C has
the option to take the entire proceeds at the insured's death, but
irrevocably elects to have the proceeds retained by the company
with the income going to C for life, remainder to GC. By exercis-
ing this option, C becomes the grantor, and since there is only one
YGB, the arrangement is not a GST.5 6 Perhaps the most impor-
tant example in the regulations involves a grantor who, by will,
assigns the beneficiaries of the estate to two different generations.
there is no GSTT,
Although this assignment is a GST equivalent,
57
provided the separate share rule applies.
custodian relaExample seven illustrates the peril of using the
58
tionship under the Uniform Gift to Minors Act:
A transfers $300,000 to his grandchild C under the Uniform
Gift to Minors Act naming A's sister as a custodian. The arrangement is a [GST] equivalent because C'sparent is treated
as a beneficiary under § 26.2613-4(c)(3) and the arrangement
splits the beneficial enjoyment of the gift among two [YGBs]
who are assigned to two different generations.5 9
This example presents an unwarranted expansion of fiduciary
54. Id. § 26.2611-4(a), 46 Fed. Reg. at 123.
55. Id. § 26.2611-4(b), example (1).
56. Id. C, of course, by electing the arrangement, may make a taxable gift of the
remainder interest under § 2501, causing the value of the proceeds to be includable in his
or her gross estate under § 2036. In that event, the transaction, even if construed to be a
GST equivalent, still would be excluded from the GSTT. Cf. I.R.C. § 2613(a)(4)(B) (1976)
("taxable distribution" does not include transfers subject to tax imposed by chapter II or
12) and (b)(5)(B) ("taxable termination" does not include transfers subject to a tax imposed
by chapter 11 or 12). It should be noted, however, that a combination life insurance policy
and annuity may be a GST equivalent. Prop. Treas. Reg. § 26.2611--4(b), example (3), 46
Fed. Reg. at 123. The same is true for a legal life estate with remainder over. Id.
§ 26.2611-4(b), example (4).
57. Id. example (5) (citing examples (3) and (4) under the separate share rule of
§ 26.2613-5(c)). See infra notes 130-41 and accompanying text.
58. UNi. GIFr TO MINORs Acr, 8 U.L.A. 181 (1972).
59. Prop. Treas. Reg. § 26.2611-4(b), example (7), 46 Fed. Reg. at 123 (emphasis added). To determine whether C has a present interest or power, see id. § 26.2613-4(d).
CASE WESTERN RESERVE LAW REVIEW
[
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power. The example correctly assumes C's parent is under a legal
obligation to support C. By analogy to cases decided under sections 2036 and 2038 of the Code,6" however, this example assumes
that the custodian has the equivalent of a beneficial power which
can be used to satisfy the legal support obligation." Under the
proposed regulations, C, the minor, has a present interest or power
due to the "unrestricted right to receive income or corpus."62 The
difficulty with the Commissioner's assumption is that the custodian has more than a true fiduciary interest. If C has an "unrestricted right to receive income or corpus, ' 63 it is difficult to see
how the custodian could have anything other than a fiduciary
power.
C. Taxable Distributions
1. Defining a Taxable Distribution
Once a trust is found to be a GST, those situations which may
be classified as "taxable distributions" must be determined. The
proposed regulations define a taxable distribution as "any distribution which exceeds the amount of trust income . . . from a
[GST] to any [YGB] who is assigned to a generation younger than
the generation assignment of any other person who is or was a
[YGB]."' 64 The distribution, therefore, must be both from a GST
and in excess of trust income, and the distributee must be assigned
60. See, e.g., Stuit v. Commissioner, 452 F.2d 190 (7th Cir. 1971); Eichstedt v. United
States, 354 F. Supp. 484 (N.D. Cal. 1972); Crocker Citizens Nat'l Bank v. United States,
1975-2 U.S. Tax Cas. (CCH) T 13,106 (N.D. Cal.); Estate of Ads Carpousis, 33 T.C.M.
(CCH) 1143 (1974); Zien v. United States" 1973-2 U.S. Tax Cas. (CCH) 1 12,964 (E.D.
Wis.); Estate of Prudowski, 55 T.C. 890 (1971), a#dper cur/am, 465 F.2d 62 (7th Cir. 1974);
Estate of Charles M. Jacoby, 29 T.C.M. (CCH) 737 (1970); Rev. Rul. 70-348, 1970-2 C.B.
193; Rev. Rul. 59-357, 1959-2 C.B. 212; Rev. Rul. 57-366, 1957-2 C.B. 618. But see Estate
of Chrysler v. Commissioner, 361 F.2d 508 (2d Cir. 1966); Rev. Rul. 74-556, 1974-2 C.B.
300.
61. Prop. Treas. Reg. § 26.2613-4(c)(3), 46 Fed. Reg. at 127.
62. Id. § 26.2613-4(d), 46 Fed. Reg. at 128. Although C's parent and C both may be
deemed to hold an interest or power, this designation resolves only the question of whether
the custodianship is a GST equivalent. Whether a taxable distribution or taxable termination exists depends on other considerations. See infra notes 194-98 and accompanying
text.
63. Id.
64. Id. § 26.2613-1(a), 46 Fed. Reg. at 123. The regulation follows the Code except
that it discusses an amount "which exceeds" income, rather than an amount "which is not
out of income." Id. The regulation also inserts the language "or was" into the definition so
as to broaden the time for the ascertainment of a YGB. Id. For the code treatment, see
I.R.C. § 2613(a)(1) (1976).
1981]
ESTATE PLANNING
to a generation younger than any other YGB. 65 One important
exception made by the Code and the regulations is that an individual who always had afuture interest or power is not a YGB
under the taxable distribution rule.6 6
After defining a taxable distribution and stating its principal
exception, the Code then mandates the source of distributions
from the GST. Any distribution out of income is deemed to be
made in descending order of generations, beginning with beneficiaries assigned to the generation that is least remote from the
grantor. 67 The proposed regulations restate this rule and give several examples of taxable distributions involving distributions of
corpus and income to more than one generation or beneficiary
within a generation.68
Taxable distributions may be contrasted with the normal in69
come tax rule on taxability of income to a beneficiary or trustee.
In the simple trust, when the trustee distributes all current income
to an income beneficiary, the trustee receives a deduction7" and
the beneficiary is taxed on the distributed income. 1 In contrast,
there is no taxable distribution for purposes of the GSTT when
the trustee distributes current income.
Most trusts, however, are complex trusts. Drafters often provide that the trustee shall pay or accumulate the trust income depending on the beneficiary's needs. These drafters also may give
the trustee power to distribute accumulated income or a portion of
principal to the income or prinicipal beneficiary or beneficiaries.
Under income tax rules, the trustee's accumulated income is sub65. I.R.C. § 2613(a)(1) (1976) uses more complicated phraseology than the proposed
regulations. The Code requires that there be at least one other YGB assigned to an older
(higher) generation than that of the distributee.
66. Id. Prop. Treas. Reg. § 26.2613-1(a)(1), 46 Fed. Reg. at 123. The Commissioner
does not provide an example of this exception's operation. It is conceivable that a planner
might create a discretionary trust in which a distribution to a YGB would not be taxable
even though an older YGB had an interest in the trust confined to a future interest or
power. If, for example, grantor, G, creates a trust to pay the income to his or her
grandchild, GC, for life, then to G's child, C, for life, remainder to the greatgrandchild,
GGC, a distribution of corpus to GC would not be a taxable distribution, since for purposes of the first sentence of I.R.C. § 2613(a)(1) (1976), C would not be regarded as a YGB,
and the distribution would not be to a YGB assigned to a generation younger than another
person who was a YGB.
67. I.R.C. § 2613(a)(2) (1976).
68. Prop. Treas. Reg. § 26.2613-1(b), (c), 46 Fed. Reg. at 124.
69. See I.R.C. §§ 641-663 (1976).
70. Id. § 651.
71. Id. § 652.
CASE WESTERN RESERVE LAW PEVIEW
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ject to income tax.7 2 If the trustee makes a distribution of accu-
mulated income in a later tax year, the beneficiary pays an
additional tax equal to the difference between the amount the beneficiary would have paid if properly taxed and the amount the
trustee actually paid.73 The accumulated income distribution is
exempt from the taxable distribution rule because, although such
distribution is income, the rule defines income as fiduciary accounting income.7 4
For income tax purposes, the concept of distributable net in-
come determines the extent to which a distribution is taxable to
the beneficiary. Distributions, to the extent covered by distributable net income, are taxed to the beneficiary.75 If the distribution is
not covered, it constitutes an "other amount" not subject to income tax. 76 Because fiduciary accounting income, rather than distributable net income, is the talisman for nontaxability of a
taxable distribution under the GSTT, there are situations when a
particular taxable distribution is subject to both the income tax
and the GSTT. If, for example, the trustee distributes an item of
principal covered by distributable net income, the beneficiary may
have to pay income tax. If the item is also considered to be "not
out of income of the trust (within the meaning of section
643(b)),"7 7 it could be a taxable distribution under the GSTT.
The Commissioner has synchronized the operation of the income
tax and GSTT in one area. For income tax purposes, the trustee
may elect to have distributions made during the first sixty-five
days of the taxable year treated as having been made on the last
day of the preceding tax year.71 If the trustee makes such an elec72. Id. §§ 661-663.
73. Id. §§ 665-667.
74. Id. § 2613(a)(1). See STAFF OF JOINT COMM. ON TAXATION, 94TH CONG., 2D
SEss., GENERAL EXPLANATION OF THE TAX REFORM Acr OF 1976, at 571 (1976) [hereinafter cited as STAFF EXPLANATION]. The information returns which the trustee prepares
(Forms 706-B(1) and (2)) and the tax return (Form 706-B) which the distributee must file
indicate that fiduciary accounting income is the key to the taxation of taxable distributions.
The trustee files Form 706-B(1) with the Internal Revenue Service and sends Form 706B(2) to the distributee. The information returns identify the deemed transferor, the trustee,
the grantor, and the beneficiary. These returns also describe the distribution and state the
trustee's fiduciary accounting income for the year. See infra note 243.
75. I.R.C. § 662(a)(1) (1976).
76. Id. § 662(a)(2).
77. Id. § 2613(a)(1).
78. Id. § 663(b). It is arguable that the commissioner's synchronization of the sixtyfive day rule with fiduciary accounting income is erroneous since id. § 2613(a)(1) refers
only to § 643(b) (fiduciary accounting income) and does not adopt all of subchapter J,
including § 663(b). The commissioner's interpretation, however, does seem to be well
ESTATE PLANNING
tion, the distribution also is considered to have been made out of
the previous year's fiduciary accounting income for purposes of
the GSTT. 79
The proposed regulations illustrate the normal operation of
the taxable distribution rule: "Assume that a discretionary trust is
established for the benefit of the grantor's child and greatgrandchild. The trustee exercises his discretion by distributing
fiduciary accounting income to the child and also makes a distribution out of corpus to the great-grandchild. 8 0° This distribution
is a taxable distribution because there is a distribution of corpus to
a YGB, and there is at least one YGB (the child) assigned to a
generation older than that of the distributee.8 '
2. Attribution of Taxable Distributions
The Code requires that a taxable distribution be deemed to be
made first out of fiduciary accounting income and then out of
corpus. To the extent that a taxable distribution is made out of
income, it is deemed to be made "in descending order of generations, beginning with the beneficiaries assigned to the oldest generation." 2 The proposed regulations amplify this basic rule by
establishing a proration device for distributions of both corpus
and income to more than one YGB. 3 In one example,8 4 the grantor, G, creates a discretionary trust for the benefit of child, C, for
life, remainder to G's greatgrandchild, GGC. G gives the trustee
power to make distributions of income and principal in any manner the trustee deems appropriate. In the tax year, the trustee distributes $100 of principal to C. In addition, $200 of income and
$100 of principal are distributed to GGC. Fiduciary accounting
income for the tax year is $300. What are the GSTT consequences? C, having received income, is not subject to the
GSTT. 5 GGC is deemed to have received $200 of nontaxable
within the spirit of the statutory scheme of the GSTT. The emphasis on fiduciary accounting income, as contrasted with distributable net income, undoubtedly will increase the importance of drafting and local law with respect to allocation of principal and income.
79. Prop. Treas. Reg. § 26.2613-1(a)(2), 46 Fed. Reg. at 122.
80. Id. § 26.2613-1(a)(3), example (1), 46 Fed. Reg. at 123-24.
81. The example emphasizes that the YGB in the older generation "has a present
interest or power in the trust." This emphasis is superfluous, since a "beneficiary," by
definition, must have a present or future interest or power in the trust. I.R.C.
§ 2613(3)(a)(1) (1976).
82.
83.
84.
85.
Id. § 2613(a)(2).
Prop. Treas. Reg. § 26.2613-1(b), 46 Fed. Reg. at 124.
Id. § 26.2613-1(c), example (1).
Even if C were given a distribution in excess of income, there would be no GSTT
CASE WESTERN RESER VE LAW REVIEW
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income and a $100 taxable distribution. Assuming that distributable net income and fiduciary accounting income are the same and
that the trustee had complete discretion as to both principal and
income, the distribution of income and principal would be prorated on the ratio of distributable net income ($300) to total distributions ($400). For income tax purposes, therefore, C is deemed
to have realized $75 and GGC, $225.86
The second illustration8 7 provides a similar proration method
for purposes of the GSTT:
A establishes a trust for his nephew B, and B's children, C and
D. The trustee is given full power to distribute income and/or
corpus among B, C, and D, in his discretion. Fiduciary accounting income for the tax year is $4,000. The trustee distributes $2,000 to B, $1,000 to C, and $2,000 to D. How are these
distributions taxed under the GSTT?
The $2,000 to B is not subject to tax. The remaining $2,000 is
prorated between C and D based on the distributions to them.
Hence, one-third of $2,000 ($667) is attributed to C and two-thirds
of $2,000 ($1,333) to D. C, therefore, pays a GSTT on $1,000 minus $667 ($333), and D pays. a GSTT on $2,000 minus $1,333
($667). Furthermore, assuming that fiduciary accounting income
and distributable net income are equal, it is necessary to prorate
the distributable net income of $4,000 among the three beneficiaries based on the ratio of distributable net income to total distributions ($5,000).8
A third example in the proposed regulations 9 illustrates that
a distribution which might be tax-free for income tax purposes
may still be subject to the GSTT; that if property other than
money is distributed, the fair market value of the property will be
subject to the tax; and that the rules under the GSTT will take
precedence over local law for determining the character of the distribution. The example is as follows:
since C is a YGB assigned to a generation that is not younger than the generation assignment of any other YGB. I.R.C. § 2613(a)(1) (1976).
86. See Treas. Reg. § 1.662(a)-3(d) (1973) (for other amounts distributed, there shall
be included in the gross income of the beneficiary an amount which bears the same ratio to
distributable net income as the amounts distributed to all beneficiaries).
87. Prop. Treas. Reg. § 26.2613-1(c), example (2), 46 Fed. Reg. at 124.
88. The taxable income to distributees under I.R.C. § 662 would be:
B:
4/Sths of $2000 = $1,600
C: 4/Sthsof$1000=
800
D: 4/5ths of $2000 = $1,600
$4,000
89. Prop. Treas. Reg. § 26.2613-1(c), example (3), 46 Fed. Reg. at 124.
ESTATE PLANNING
Assume a [GST] received stock dividends during the year with"
a fair market value of $100,000. The dividends are treated as
corpus under local law. The trust's [fiduciary accounting income] for the year was $60,000. At the end of the year the
trustee distributes the stock dividend in equal shares to the
grantor's child and grandchild. Even though local law treats
the stock as corpus, for purposes of the [GSTT] the $50,000
stock distributed to the child is treated as a distribution of income, and the $50,000 in stock distributed to the grandchild is
treated as a $10,000
distribution of income and a $40,000 distri90
bution of corpus.
Although the Commissioner does not expressly say so, the
$40,000 would be subject to the GSTT, since it is a distribution to
a YGB, the grandchild, who is assigned to a generation younger
than that of another YGB, the child.
3.
Other Rules Affecting Taxable Distributions
Two important exceptions to the normal taxable distribution
rules include the $250,000 exclusion for transfers to the grantor's
grandchildren and the exclusion of any transfer which is "included in the federal gross estate or is subject to gift tax without
regard to section 2503(b)." 9 1 The phrase "without regard to sec-
tion 2503(b)" reveals that under ERTA, the $10,000 exclusions are
not considered in determining whether the transfer is "subject to
gift tax."92
The proposed regulations track the Code by noting that the
GSTT payment by the trustee will result in an additional taxable
distribution to the beneficiary.9 3 Such a route might be appropriate for gift tax purposes, but would be disastrous for purposes of
the GSTT, since the additional taxable distribution would cause
tax escalation for the beneficiary. 94 Finally, the Commissioner
90. Id.
91. LId. § 26.2613-1(d).
92. It might be argued that this exception language has the effect of treating transfers
subject to the $10,000 exclusion as being subject to the GSTT. This interpretation requires
some written record of all prior gifts under $10,000. Administratively, this requirement
would pose very difficult problems for the commissioner.
93. I.R.C. § 2613(a)(3) (1976); Prop. Treas. Reg. § 26.2613-1(e), 46 Fed. Reg. at 124.
94. In the background discussion of taxable distributions, the Commissioner makes
this additional comment:
The proposed regulation under § 26.2613-1 defines the term "taxable distribution" and provides, in part, that if any portion of the tax imposed on a generationskipping transfer is paid by the trust and the amount of the tax is not included in
the tax base, then the amount of the taxes paid by the trust is another generationskipping transfer. This latter transfer is treated as having occurred at the same
time as the generation-skipping transfer that caused the imposition of tax. This
CASE WESTERN RESERVE LAW REVIEW
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has included a warning in the proposed regulations that a taxable
distribution will occur if "either the loan or ([loan] renewal) or the
security arrangement [by the trustee] is not bona fide."9 5 The
trustee, therefore, must disclose: "[1] Whether the debt is evidenced by a note signed by the beneficiary, and if there is a note, a
copy of the note, [2] The amount of the loan and stated interest,
and [3] Whether the loan is secured."96 The Commissioner's directives are not based on the Code, but on the prevention of tax
avoidance. 97
D. Taxable Terminations
The GSTT is imposed on generation-skipping transfers. These
transfers normally occur when the interests or powers of one or
more YGB's terminate and new interests and powers arise in the
next succeeding generation. It is necessary to determine, therefore, how the GSTT is measured and who must pay it.
If the GSTT were imposed only on the termination of a beneficiary's interest, the tax could be avoided easily by a series of distributions prior to the ultimate termination of the beneficiary's
interest. The taxation of taxable distributions serves as a backstop
for the taxation of taxable terminations in much the same way as
the gift tax serves as a backstop for the estate tax.
1. Defining Taxable Termination
The Code defines a taxable termination as "[t]he termination
(by death, lapse of time, exercise or non-exercise, or otherwise) of
the interest orpower in a [GST] of any [YGB] who is assigned to
any generation older than the generation assignment of any other
person who is a [YGB]." 9 8 The Code excludes from a "taxable
termination" the termination of any interest or power of a person
having only afuture interest or power. 99 The proposed regulawill result in the generation-skipping transfer being grossed-up by the amount of
taxes attributable to that generation-skipping transfer.
See also Taxable Distribution and Taxable Terminations, 46 Fed. Reg. 120, 120.
95. Prop. Treas. Reg. § 26.2613-1(f)(1), 46 Fed. Reg. at 124.
96. Id. § 26.2613-(t)(2).
97. H.R. REP. No. 1380, 94th Cong., 2d Sess. 52 (1976) [hereinafter referred to as
House REPORT].
98. I.R.C. § 2613(b)(1) (1976) (emphasis added).
99. Id. § 2613(b)(1). Conceivably, drafters may attempt to convert what might otherwise be a present interest or power into a future interest or power by providing for the
giving of notice before the beneficiary would be deemed to have an interest. See McCaffrey, PlanningforGeneration-Skpping Transfers, 14 REAL PROP., PROB.& TR. J. 722, 730
(1979). The Commissioner has said that an interest or power shall be treated as a present
1981]
ESTATE PLA NNING
tions also exclude the assignment of a beneficiary's interest in a
GST, regardless of whether it is for a valuable consideration. 100
2. Postponement of Taxable Terminations
Since the GSTT is meant to fall precisely when the interest or
power of a beneficiary assigned to an older generation occurs, iso-
lating this point in time becomes crucial. The Code and the propoed regulations must prevent indefinite postponement of the tax.
Taxable termination will be deferred in four situations: when
there are two or more YGB's of the same generation; 10 ' when a
YGB has more than one interest or power;' 0 2 when the interest of
a YGB assigned to a younger generation is terminated, but there
is still an interest outstanding in another YGB assigned to an
older generation;" and when the termination of an interest assigned to a YGB assigned to a younger generation causes an inter-
est to arise in another YGB assigned to the same or older
generation."
n
All four of these situations are corollaries to the
basic principle that no taxable termination occurs until the older
generation is no longer involved with the trust.
Two important caveats, however, must be added to these corollaries. First, the rules apply only if the beneficiaries' interests
are substantial. 5 Second, the rules apply separately when the
trust instrument creates separateshares or separate trusts. 0 6
a. Two or More YGB's. When there are two or more YGB's
interest or power "as long as the interest or power arises annually." Prop. Treas. Reg.
§ 26.2613-2(c)(2), 46 Fed. Reg. at 126.
100. Prop. Treas. Reg. § 26.2613-2(a), 46 Fed. Reg. at 125. Such an assignment, if for
less than adequate consideration, is subject to the gift tax and exempt under I.R.C.
§ 2613(b)(5)(B) (1976). Conceivably, the GSTT could be avoided by an assignment. If S,
created a trust with S2 as life tenant, and child, C, as remainderman, there would be no
GST present. C then might assign one-half of the remainder interest to his or her child,
GC (S's grandchild), and the other one-half to GC's grandchild, GGC (S,'s greatgrandchild). If there is no amalgamation of Sl's original trust with C's assignment, there is
no GST. For this plan to work, the interests of C must be assignable under local law.
101. I.R.C. § 2613(b)(2)(A) (1976); Prop. Treas. Reg. § 26.2613-2(b)(1), 46 Fed. Reg. at
126. See infra notes 107-08 and accompanying text.
102. I.R.C. § 2613(b)(2)(B) (1976); Prop. Treas. Reg. § 26.2613-2(c), 46 Fed. Reg. at
126. See infra note 109 and accompanying text.
103. I.R.C. § 2613(b)(2)(C)(1) (1976); Prop. Treas. Reg. § 26.2613-2(d), 46 Fed. Reg. at
126. See infra 110-17 and accompanying text.
104. I.R.C. § 2613(b)(2)(D) (1976); Prop. Treas. Reg. § 26.2613-2(b)(2), 46 Fed. Reg. at
125.
105. See infra notes 118-31 and accompanying text.
106. See infra notes 132-43 and accompanying text.
C4SE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
of the same generation, all their interests terminate when the interest of the generation's last YGB terminates. If, for example, B,
C, and D, children of the settlor, are beneficiaries of the same discretionary trust, and the trust is to continue for their joint lives
and the life of the survivor, the taxable termination occurs when
the last of the three children dies. 7 The House Ways and Means Committee explained that the
"tax is postponed in the case of a discretionary (or sprinkling)
trust because it is difficult to value the terminated interest until all
members of the intervening generation have terminated their interests ...
"1
b. Same Beneficiary Having More Than One Interest or
Power. The proposed regulations reiterate the statutory rule that
if a YGB has more than one present interest or power in the trust,
the taxable termination occurs when the last present interest or
power terminates.10 9
c. Unusual Order of Termination. The interest or power of a
YGB assigned to an older generation usually will terminate prior
to that of a YGB assigned to a younger generation. If, however,
the reverse situation occurs, the Code and proposed regulations
dictate that the taxable termination be deferred until the interest
or power of the older beneficiary terminates. 1 0 At this time, the
GSTT is applied first to the termination of the interest or power of
the older YGB, "[a]s if such termination occurred before the termination. . . of the younger beneficiary, [and] the value of the
property taken into account for purposes of determining the tax
. . . with respect to the termination. . . of the younger beneficiary shall be reduced by the [GSTT] with respect to the termination . . . of the older beneficiary.""' The Commissioner
illustrates the rule with the following example:
Assume A creates a generation-skipping trust with the income
payable in the sole discretion of the trustee to A's child B and
A's grandchildren C and D, for the life of B. Upon the death of
B the corpus of the trust is to be distributed to A's then living
107.
108.
109.
110.
at 126.
111.
at 126.
Prop. Treas. Reg. § 26.2613-2(b)(5), example (1), 46 Fed. Reg. at 125.
HousE REPORT, supra note 97, at 50.
Prop. Treas. Reg. § 26.2613-2(c)(1), 46 Fed. Reg. at 126.
I.R.C. § 2613(b)(2)(C)(ii) (1976); Prop. Treas. Reg. § 26.2613-2(d)(2), 46 Fed. Reg.
I.R.C. § 2613(b)(2)(C)(ii) (1976); Prop. Treas. Reg. § 26.2613-2(d)(2), 46 Fed. Reg.
ESTATE PLA4NNING
issue per stirpes.
n Further, assume that C predeceases B leaving
one child E.1
Using these facts, the death of C is not a taxable termination.
3
Upon B's death, one-half of the property-is distributed to D, 1
and a GSTT is imposed on that one-half. The other one-half of
.the property passes to E and is treated as having passed through
two generation-skipping transfers, one from B to C and a second
from C to E. I 4 The value of the property taxed on the second
transfer from C to E is reduced by the amount of the tax on the
transfer from B to C." 5
If the present interest or power of a YGB assigned to a
younger generation terminates, and immediately after such termination, another YGB assigned to the same or higher generation
has a present interest or power arising from such termination, the
taxable termination for each YGB is deemed to occur with the
termination of the YGB assigned to the older generation. 6 For
example, A creates a generation-skipping trust for A's grandchild,
B, who has cancer. On B's death, A's child, C, will become the life
beneficiary of the trust. At the death of C, the corpus of the trust
will be distributed to A's greatgrandchild, D. In this situation, assuming C survives B, there is a taxable termination of each interest at the death of C. The GSTT will be applied in the same
7
manner as in the case of an unusual order of termination."1
d. The Caveats. Having considered the principal situations
when taxable terminations are postponed, the Commissioner then
articulates two situations where the prevention of tax avoidance
requires additional regulations. The first, the separate share rule,
is familiar to estate planners from the income taxation of trusts.
The second, dealing with nominal interests, is designed to prevent
the planner from unduly postponing the incidence of tax through
the creation of many interests in beneficiaries who have no real
interest in the trust.
The Code defines a beneficiary for purposes of the GSTT as
"any person who has a present or future interest or power in the
trust."' 8 A person has a trust interest if such person has "a right
112.
113.
114.
115.
116.
117.
118.
Prop. Treas. Reg. § 26.2613-2(b)(5), example (5), 46 Fed. Reg. at 125.
Id. It is assumed that the grandchild exclusion already has been exhausted.
Id.
See id. § 26.2613-2(d)(3), example (1), 46 Fed. Reg. at 126.
Id. § 26.2613-2(b)(2).
I.R.C. § 2613(b)(2)(D) (1976).
Id. § 2613(c)(3).
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
to receive income or corpus from the trust, or is a permissible recipient of such income or corpus."' 19
A power is "any power to establish or alter beneficial enjoy-
ment of the corpus or income of the trust."1 20 For purposes of
postponement of the incidence of the GSTT, the proposed regulations require that a beneficiary's interest or power be substantial.121 Without this requirement, drafters of trust instruments
could postpone the GSTT incidence simply by naming many unrelated trust beneficiaries of the same or higher generation as
those whom the settlor intends to benefit.122
To prevent this situation, the proposed regulations state that if
the beneficiary is not a lineal descendant of the grantor's grandparent, the interest will be deemed substantial only "[i]f at least 5
percent of the value of the trust. . . is distributed to the nonlineal
descendant[s] . . . annually."1 23 If less than five percent is distributed to nonlineal descendants, the interest is nominal "unless
unusual facts and circumstances indicate that it is substantial."'
24
By definition, the interest of a lineal descendant of the grantor's
grandparent is substantial.'2 5 If a beneficiary's interest is not substantial, it is "nominal." For tax purposes, the value of a nominal
interest does not reduce the value of the terminated interest, and
126
its termination is not a taxable event.
The application of the five percent rule for determining
whether a beneficiary has a substantial interest may prove difficult
in future years. With interests, the five percent determination is
easier, since it is based on the relative values of the trust and property distributed annually. As applied to a power, the valuation
becomes difficult because the five percent rule is based on the rela119. Id. § 2613(d)(1).
120. Id. § 2613(d)(2)
121. Prop. Treas. Reg. § 26.2613-2(b)(3), 46 Fed. Reg. at 125.
122. This approach is reminiscent of similar efforts to postpone vesting by using ascertainable groupings as "all lineal descendants of Queen Victoria living at. . .[my] death"
as the measuring lives for purposes of the rule against perpetuities. T. BERGIN & P. HASKELL, supra note 28, at 188 (citing In re Villar, I Ch. 243 (1929)).
123. Prop. Treas. Reg. § 26.2613-2(b)(3)(iii), 46 Fed. Reg. at 125.
124. Id. It is difficult to determine what might be considered unusual facts and circumstances. If it were shown that the settlor had a close relationship with the unrelated beneficiary, this evidence might be sufficient to make the five percent test immaterial.
125. Id. Whether this definition is realistic depends on the particular case. The grantor
conceivably could list many first cousins who have little contact with the grantor. Conversely, the grantor might have a very close relationship with a daughter-in-law, who is
"unrelated" for purposes of the regulation, even though she is in the same generation as the
grantor's son, regardless of her age.
126. Prop. Treas. Reg. § 26.2613-2(b)(3)(i), 46 Fed. Reg. at 125.
19811
ESTATE PLANNING
tive values of the trust and the right to withdraw corpus or income.1 27 The rule attempts to alleviate the problem of
applydetermining the value of a right to receive income by only
128
standard.
external
ascertainable
an
with
ing to powers
Although the five percent rule is the primary method for determining the substantiality of a beneficiary's interest, an interest
or
circumthe
facts
and
"if
under
all
as
nominal
power still is treated
stances the holder of that interest or power was never intended to
exercise or benefit from the power or interest."'129 The Commissioner illustrates the rule with the following examples:
(A) Assume a [GST] is established with the income payable
to the settlor's grandchildren A and B for their joint lives and
for the life of the survivor and upon the death of the last survivor the income is payable to C and D for their joint lives or
accumulated and upon the death of C and D, the corpus is
thereafter to be distributed to the great-grandchildren of the
settlor. Both C and D are unrelated members of A and B's
generation. If the sum of the annual distributions to C and D is
at least 5 percent of the value of the trust, no taxable termination will occur until the death of the survivor of C and D or the
sum or the distribution13in
0 a given year is less than 5 percent of
the value of the trust.
(B) Assume the same facts. . . except that the trustee distributed 5 percent of the income to C and D the first year their
interests became a present interest. Unless unusual facts indiless
cate otherwise, C and D have a nominal interest because
131
than 5 percent of the value of the trust was distributed.
Assuming the planner is willing to pay for the privilege, the
regulations establish a method for deferring a taxable termination
for a group of beneficiaries for a long period of time.
A drafter can create a discretionary trust for the testator's
grandchildren, with gifts over to the settlor's greatgrandchildren
a beneficiary possesses the right to
127. Id. § 26.2613-2(b)(3)(ii) provides that "[ilf
withdraw income or receive income or corpus (or both), thepresentvalue of which at the
time of the termination is at least 5 percent of the trust, then the beneficiary's interest is
substantial." Id. (emphasis added).
128. Id. When the beneficiary's needs are so remote as to be negligible, the power will
be excluded from the five percent rule. Id. This acknowledged distinction between different powers is contrary to the policy of the income, estate, and gift taxes. Historically, a
transfer subject to the retention of such a power was deemed complete for purposes of all
three taxes. Cf.Leopold v. United States, 510 F.2d 617 (9th Cir. 1975) (estate tax); Jennings v. Smith, 161 F.2d 74 (2d Cir. 1947) (estate tax); I.LC. § 674(b)(5)(A) (1976) (income
tax); Treas. Reg. § 26.2511-2(c) (gift tax).
129. Prop. Treas. Reg. § 26.2613-2(b)(3)(iv), 46 Fed. Reg. at 125.
130. Id. § 26.2613-2(b)(5), example (3).
131. Id., example (4) (emphasis added).
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
upon the termination of the trust. The drafter next prepares a list
of persons unrelated to the grandchildren but of their generation
(not younger than twelve and one-half years younger than the
youngest grandchild). These persons and the grandchildren are
made beneficiaries of a discretionary trust in which the trustee has
the power to distribute corpus or income to beneficiaries. Upon
the death of the last grandchild, the trust is continued until the
death of the last unrelated beneficiary. During this period, the
trustee distributes each year a minimum of five percent of the trust
value (valued as of the first day of the trust's tax year) to the unrelated beneficiaries as a group and accumulates any income exceeding this amount for the principal beneficiaries' benefit. There
is no taxable termination until the last unrelated beneficiary dies.
The obvious difficulty of such a draft is that its necessary complexity may not be warranted by the testator's estate planning
objectives. Like the involved efforts of some drafters to postpone
vesting for purposes of the rule against perpetuities, however, such
a draft defers taxable termination for a long time.
The Code states the general rule that "in the case of a single
trust having more than one beneficiary, substantially separate and
independent shares of different beneficiaries in the trust shall be
treated as separate trusts."' 3 2 The following proposed regulation
illustrates this rule:
Assume that A establishes a trust for the benefit of his two children, B and C. Under the terms of the trust 50 percent of the
income must be paid annually to each child and upon the death
of either child, 50 percent of the corpus 33of the trust is to be
distributed to that child's grandchildren.
On these facts, the separate share rule applies, and a taxable termination occurs at the death of either B or C with respect to that
1 34
child's share.
The separate share rule governing the income taxation of
trusts is equally applicable to the GSTT.135 Even if shares are not
considered separate for income taxation purposes, they still may
be separate for GSTT purposes. 36 In the past, planners used the
separate shares principle to gain income tax advantages. 137 Under
132.
133.
134.
135.
136.
137.
I.R.C. § 663(1) (1976).
Prop. Treas. Reg. § 26.2613-5(c), example (1), 46 Fed. Reg. at 128.
Id.
Id. § 26.2613-5(b)(1).
Id. § 26.2613-5(b)(2), (c), example (4).
The principal advantage of creating separate shares for income tax purposes is
that the additional taxable entities cut the effective income tax brackets of the beneficiaries.
1981]
ESTATE PLANNING
the GSTT, however, drafters normally seek to avoid the separate
share rule. 3 s It, of course, is possible to have a GST when only a
portion of the trust is subject to the separate share rule. The Com-
missioner illustrates this possibility with the following example:
Assume a trust is created by A with 50 percent of the income
payable in the sole discretion of the trustee to A's children B
and C for their lives and for the life of the survivor, and upon
the death of the survivor 50 percent of the corpus is to be distributed to the children of B and C per stirpes. The remaining
50 percent of the income is payable to the grantor's nephew D
for life and upon the death of D the remaining
3 50 percent of the
corpus is to be distributed to D's children.1
The separate share rule applies to the relationship between D, as
an individual, and B and C, as a group. The mutual interests of B
and C are not subject to the separate share rule.
While the planner often will want to avoid the separate share
rule to postpone a taxable termination as long as possible, there
are times when using the rule can be beneficial. The planner may
use separate shares when only one YGB (or one generation of
YGB's) for each share (or trust) is desired. The Commissioner
illustrates this situation thus: "Assume that A dies leaving A's en-
tire estate in equal shares to A's child B, B's child C and C's child
D. Under A's will, B has the right to receive all the income from
the entire estate during the period of administration."' 4 ° On these
facts, the Commissioner reaches the surprising conclusion that
"[t]he separate share rules do not apply," and when the estate is
closed, a taxable termination will occur as to two-thirds of the estate value. 14 1 Interestingly, if the drafter provides that during the
This advantage is limited by the special rules governing the income taxation of accumulation distributions. See I.R.C. §§ 665-667 (1976). Separate shares (or separate trusts) still
may be used, however, with appropriate discretion in the trustee to create greater flexibility
in the handling of distributable net income. See id. §§ 661-662.
138. This is assuming that the planner is not seeking to leave separate shares or separate trusts for each succeeding generation.
139. Prop. Treas. Reg. § 26.2613-5(c), example (2), 46 Fed. Reg. at 128.
140. Id., example (3). This example is troublesome since it seems to assume, in contrast
with example (4), that the administration of the estate in which B is entitled to all the
income is a trust equivalent. This assumption is inconsistent with the distinction between
the income taxation of estates and the income taxation of trusts, as outlined in subchapter
J. See Treas. Reg. § 1.661(a)-I (1959). Example (3) notwithstanding, the rights of C and
D are nothing more than a right to a one-third interest in A's estate. B, likewise, has a right
to one-third of A's estate, but also is entitled to all the income during the estate's administration. This arrangement is not the same as a trust in which the income is to be paid to B
for a period certain, or for life, with remainders over to B, or B's estate, and to C and D, or
their estates.
141. Prop.. Treas. Reg. § 26.2613-5(c), example (3), 46 Fed. Reg. at 128.
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
administration period, B, C, and D each shall have the right to the
income from their respective shares, there is no taxable termination when the estate is closed. 142 All beneficiaries receive their
43
estate shares, and there is only one YGB as to each share.1
E. Exclusionsfrom Taxable Distributionsand Taxable
Terminations
The Code provides for two major exclusions from taxable distributions and taxable terminations: an exclusion of $250,000 as
to any deemed transferor for transfers to the grantor's grandchildren; 144 and an exclusion of any transfer which is "subject to" fed45
eral estate or gift taxes.1
1. The $250,000 Exclusion
Of primary importance to estate planners is the $250,000 exclusion allowed deemed transferors for transfers to the grandchildren of the grantor. If grantor, G, establishes a testamentary trust
to pay the income to grandchild, GC, for life, then to GC's child,
GGC, for life, remainder to the children of GGC, there is no exclusion at the death of GC or GGC. The taxable termination at
the death of GC is on a transferfrom G's grandchild. If the trust
is changed so that income goes to 's child for life, then to GC for
life, remainder to such persons as GC appoints, or to GC's estate,
the $250,000 exclusion is available for the taxable termination on
the death of the grantor's child. Note that the limitation is worded
so that the property must be included in GC's gross estate for federal estate tax purposes. This requirement stems from the regulations which state that "[tihis exclusion is available only if the
property would be includable in all events in the grandchild's federal gross estate if the grandchild
died at any time after the gener46
ation-skipping transfer."
The $250,000 exclusion is typically available for each deemed
142. Id., example (4).
143. Id.
144. I.R.C. § 2613(b)(6) (1976). Section 2613(a)(4)(A) provides the basis for this exclusion by providing that "Ithe term 'taxable distribution' does not include. . . any transfer
to the extent such transfer is to a grandchild of the grantor of the trust and does not exceed"
the $250,000 limitation. Id. See id. § 2612(a) (deemed transferor defined).
145. Id. § 2613(a)(4)(B). See infra notes 152-53 and accompanying text.
146. Prop. Treas. Reg. § 26.2614-4(a), 46 Fed. Reg. at 128. The precise origin of this
limitation is unclear. There is no reason why a joint and survivor annuity in C and GC
should not qualify for the exclusion on the death of C, GC surviving, even though nothing
is included in GC's estate. But see infra note 148.
ESTATE PLANNING
transferor. The number of exclusions, therefore, is multiplied by
the number of the grantor's children expected to become deemed
for example, grantor has four children, A, B, C,
transferors. If,
and D, up to one million dollars can be transferred without incidence of tax on the termination of the interests of A, B, C, and D.
To obtain the maximum tax advantage in this situation, the planner might choose to establish two discretionary trusts. The first
would involve the transfer of $1 million to trustees for the joint
lives of A, B, C, and D, and for the life of the survivor, remainder
to the grantor's grandchildren. 147 In the second trust, all property
exceeding that amount would be transferred to the grandchildren
for their joint lives and life of the survivor, remainder to the grantor's greatgrandchildren.
The Code offers no clear basis for the requirement that property "be includable in all events in the grandchild's federal gross
49
estate,"'148 although it is mentioned in the staff explanation.1 If
grantor, G, transfers property to child, C, for life, then to
grandchild, GC,for life, remainder to the children of GC, there
are two taxable terminations, one at the death of C, and another at
the death of GC. Since the imposition of the GSTT upon the
death of GC would produce the same transfer tax revenue as the
estate tax if property were includable in GC's gross estate, there is
no reason why the $250,000 exclusion should be denied at C's
death, because the gift over following GC's life estate is a remainder interest, rather than a transfer to the estate of GC or to GC's
appointees.
When several taxable distributions or taxable terminations are
subject to the $250,000 exclusion, it "is to be applied against the
first distribution or termination that occurs, then the second, and
so forth, until the exclusion has been fully utilized." 150 In addition, "[i]f there are simultaneous transfers which are attributable
to the same deemed transferor and which benefit more than one
grandchild of the grantor of the trust, the $250,000 exclusion is to
147. Alternatively, the grantor might provide for life estates in the children with re-
mainders to such persons as each child might appoint from among his or her lineal descendants. Although such a draft would necessitate the application of the separate share
rule, the $250,000 exclusion would eradicate any adverse effect.
148. Prop. Treas. Reg. § 26.2614-4(a), 46 Fed. Reg. at 127.
149. "This $250,000 exclusion is to be available in any case where the property vests in
the grandchild (i.e. the property interests will be taxable in the grandchild's estate) .
STAFF ExPLANATION, supra note 74, at 572.
150. Prop. Treas. Reg. § 26.2613-4(a)(1), 46 Fed. Reg. at 127. See also HOUSE REpoRT,supra note 97, at 52.
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
be allocated between the transfers in accordance with their fair
market values."''
2.
The Estate and Gft Tax Exclusion
In the absence of an express provision excluding transfers from
the GSTT which are either subject to the estate and gift tax or
contrary to congressional intent, some taxable distributions or taxable terminations could be subject to more than one transfer tax
per generation. Assume that grantor, G, transfers property in
trust to a grandchild, GC, for life, remainder to such persons as
GC appoints by will, with a gift over to G's greatgrandchild,
GGC, in default of appointment. Upon GC's death, there is a taxable termination when both GC's interest and power in the GST
terminate. But since the property also is included in GC's gross
estate under section 2041 of the Code, it is proper to exclude that
property from the GSTT. 5 2 If GC exercises the power of appointment in favor of GGGC (GC's grandchild and G's great-greatgrandchild) rather than GGC, the exclusion presumably still
applies even though GGC's generation is effectively skipped.
The proposed regulations added little to the exclusion provided by the Code. These regulations, however, expressly provide
that the $10,000 exclusion for gift tax purposes is to be disregarded
in determining whether a particular transfer is "subject to gift
tax."' 153 Thus, the exemption from application of the GSTT applies to the whole transfer.
F. The Role of the Deemed Transferor
Under the GSTT statutory plan, the deemed transferor's tax
position determines the measure of the tax. The tax is paid by the
recipient in a taxable distribution and the trustee in a taxable termination. Assume, for example, that G transfers property to trustees to pay the income to a GC for life, remainder to GGC. All the
requirements of a GST are satisfied: (1) There are two generations of YGB's; (2) they are assigned to more than one generation; and (3) both generations are younger than G's. At GC's
death there is a taxable termination, and GC is the "deemed
151. Prop. Treas. Reg. § 26.2613-4(a)(2), 46 Fed. Reg. at 127. See also HousE REPORT, supra note 97, at 53.
152. I.R.C. § 2613(a)(4)(B) (taxable distributions), (b)(5)(B) (1976) (taxable terminations).
153. Prop. Treas. Reg. § 26.2613-1(d) (taxable distributions), -3(c), 46 Fed. Reg. at
124-26 (taxable terminations). See supra note 92 and accompanying text.
19811
EST.ATE PLANNING
transferor," "[tihe parent of the transferee [i.e., GGC] of the property who is more closely related to the grantor. . . than the other
parent of such transferee."' 54
If during GC's life, the trustee distributes only income, GC
will pay income tax on the money received. If, however, the
trustee delivers a portion of principal to GC, there is no taxable
distribution, since GC is assigned to the oldest generation of
YGB's under the trust.15 5 Upon GC's death, the tax issues become critical. The amount of the GSTT on the taxable termination is based on the fair market value of the trust property as of
GC's death.' 56 To insure that GC's tax bracket determines the
amount of tax on this value, the tax is first computed based on the
total fair market values of all prior transfers, plus the present
transfer.' 57 From this amount, the tax on all prior transfers,
whether by gift, estate, or GST, is subtracted. 5 8 The difference is
the amount of the GSTT on this particular transfer at the appropriate tax rate.' 59 This calculation has been used for gift tax purposes since 1932,160 and for both federal estate and gift tax
purposes since 1976.161
The proposed regulations mirror the statute in defining the
deemed transferor as the transferee's parent more closely related
to the grantor. 62 If neither parent is related to the grantor, then
the deemed transferor will be the parent "having a closer affinity
to the grantor."' 163 This situation is illustrated by the following
example: Assume, in the previous example, that GGC was the
child of SI and S2 . After SI's death, GC married S2, so that GGC
became GC's stepchild. Neither S, nor S 2, the parents of GGC, is
related to grantor. S 2, however, is the deemed transferor since, as
the spouse of GC, S2 is "the parent having a closer affinity to the
154. LR.C. § 2612(a)(1) (1976).
155. A taxable distribution is defined as a distribution "not out of. . . income... to
any [YGB] assigned to a generation younger than... any other [YGB]." Id. Hence, a
distribution to a YGB assigned to the oldest generation of YGB's is not a taxable
distribution.
156. Id. § 2602(a).
157. Id. § 2602(a)(1)(A), (B), (C), (D).
158. Id. § 2602(a).
159. Id.
160. Rev. Act of June 6, 1932, Pub. L. No. 72-154, § 502, 47 Stat. 177, 246 (codified at
LR.C. § 2502 (1976)).
161. 1.1.C. § 2001(b) (1976).
162. Prop. Treas. Reg. § 26.2612-1(a), 46 Fed. Reg. at 123.
163. Id.
CASE WESTERN RESERVE LW REVIEW
[Vol. 32:105
grantor."' 6" If, in the first example, C, rather than GC, were the
life beneficiary of the trust, C, not GC, would be the deemed
transferor. The Code and regulations provide for this result by
stating that if the parent (GC) of the transferee (GGC) is not a
YGB, "but 1 or more ancestors of the transferee is a. . .[YGB]
related by blood or adoption to the grantor of the trust, the youngest of such ancestors"'165 will be the deemed transferor. Although
adoption and marriage are equally significant in the determination of generation assignment, a parental relationship to the grantor by blood or adoption takes precedence over a relationship by
marriage in determining the deemed transferor. 66 Thus, if the
spouse of GC, S2, were the life beneficiary in the original example,
GC is still the deemed transferor, being more closely related to the
grantor than S 2.
The rules stated in the Code for identification of the deemed
transferor are incomplete. Suppose, for example, that grantor, G,
transfers property in trust to a child, C, for life, remainder to GC's
spouse, A. Which of the two parents of A has the "closer affinity"
to G? 167 The Commissioner states that the older parent of A is the
68
deemed transferor.
The Code defines "deemed transferor"'' 69 but says nothing
about the transferee. T0 The proposed regulations list several persons or groups of persons as transferees: in a taxable distribution,
the transferee is the person who receives money or property or has
it applied for his or her benefit;' 7 ' in a taxable termination which
terminates the trust and requires the distribution of the trust
corpus to one or more beneficiaries, the transferee is the person
164. Id. In this example, in the absence of an adoption of GGC by GC, GGC would
not be a "lineal descendant of a grandparent of the grantor," and GGC's generation would
be ascertained on the basis of the date of his or her birth. I.R.C. § 261 l(c)(1), (4), (5)
(1976).
165. I.R.C. § 2612(a)(2) (1976); Prop. Treas. Reg. § 26.2612-1(a), 46 Fed. Reg. at 123.
166. I.R.C. § 2612(b) (1976); see Prop. Treas. Reg. § 26.2612-1(a), 46 Fed. Reg. at 123.
167. I.R.C. § 2612(a)(1) (1976). The exception of § 2612(a)(2) is inapplicable, since
none of A's ancestors is a YGB.
168. Prop. Treas. Reg. § 26.2612-1(a), 46 Fed. Reg. at 123. This regulation provides
that "[i]f the parent is not named in the will or trust instrument, or the lineal descendant of
that parent does not have an intervening interest or power in the trust, then the older parent
is treated as the deemed transferor with respect to all of the property transferred." Id.
(emphasis added).
169. See I.R.C. § 2612(a) (1976).
170. The staff explanation recognized that the term "transferee" was to be "further
defined in regulations [to] prevent situations where attempts are made to minimize tax
through the use of nominal transferees." STAFF EXPLANATION, supra note 74, at 578.
171. Prop. Treas. Reg. § 26.2612-1(b), 46 Fed. Reg. at 123.
1981]
ESTATE PL,4NNING
172
who receives the property, or has it applied to his or her benefit;
in a taxable termination where the trust continues after termination, the transferee is the person (or persons) with a present interest or power in the trust immediately after the taxable
termination; 173 in a transfer to an entity, the transferees are those
persons who are assigned to a generation and are treated as transferees to the extent of the fair market value of their interest in the
entity; 74 and in a charitable organization, charitable trust, or accumulation trust, having a present interest or power in the trust
immediately after the taxable termination or having a mandatory
accumulation of income for a term of years, the transferee is the
having the next succeeding present interest or present
person 75
power. 1
If, upon taxable termination, the trust assets are not actually
distributed to a beneficiary, or if the distribution is to an entity,
the property is "deemed transferred pro rata to all beneficiaries
with a present interest or present power"' 7 6 in the following priority order: first, to those assigned to the oldest generation who are
lineal descendants of both the grantor and the beneficiary whose
interest or power has been terminated; 177 second, to those assigned
to the oldest generation who are lineal descendants of the grantor;178 third, to those assigned to the oldest generation who are
lineal descendants of the beneficiary whose interest or power has
terminated; 179 fourth, to those assigned to the oldest generation
who are lineal descendants of the grantor's grandparents; 8 0 and
finally, to all beneficiaries holding present interests or present
sti.pes, unless the trust instrument specified per
powers 8per
1
capita.'
The Commissioner has illustrated the application of these
rules with two examples. In the first example, grantor establishes
a discretionary trust with child A as beneficiary. Grantor also
names A's children, B and C, and Grantor's greatgrandchildren,
D and E, as beneficiaries, and directs that the trustee pay the in-
172.
173.
174.
175.
176.
Id.
Id.
Id.
Id.
Id. § 26.2613-3(a)(1), 46 Fed. Reg. at 126.
177. Id. § 26.2613-3(a)(1)(i).
178. Id. § 26.2613-3(a)(1)(ii).
179. Id. § 26.2613-3(a)(1)(iii).
180. Id. § 26.2613-3(a)(1)(iv).
181. Id. § 26.2613-3(a)(1)(v).
CASE WESTERN RESERVE LAW REVIEW
[
[Vol.
32:105
come to the beneficiaries and survivors. Upon the death of the
last survivor, the trustee is to distribute the principal to the children of D and E. A dies, causing a taxable termination.18 2 Since B
and C are members of the oldest generation succeeding A's generation and are lineal descendants of both grantor and the beneficiary whose interest has terminated, they are the transferees at A's
death, and the trust property is transferred one-half to each. 8 3 In
the second example, grantor establishes a discretionary trust for
the benefit of grantor's child, A, for life, then to A's child, B, and
grantor's nephew, C, for their lives and the life of the survivor. At
the death of the survivor, the principal of the trust is to be distributed to B's children. 8 4 Upon A's death, B is assigned to the oldest
generation and is the lineal descendant of both grantor and beneis the
ficiary, A, whose interest has terminated. B, therefore,
85
transferee, and B's parent, A, is the deemed transferor.
G. Interests and Powers
The GSTT is imposed only on taxable distributions or taxable
terminations from a GST. A distribution is taxable only if it is
made to a YGB assigned to a generation younger than that of at
least one other YGB. A termination is taxable only if the interest
or power of a YGB assigned to an older generation is terminated,
and there is86 at least one other YGB assigned to a younger
generation. 1
1. The Basic Rules
A YGB must first be a "beneficiary" of a trust or its
equivalent. A beneficiary is "any person who has a present or future interest or power inthe trust."'1 87 "A person has an interest in
a trust if such person. . . has a right to receive income or corpus
from the trust, or. . .is a permissible recipient of such income or
88
corpus." 1
The Code defines power as [the ability] to establish or alter the
182. Id. § 26.2613-3(a)(2), example (1).
183. Id.
184. Id. § 26.2613-3(a)(2), example (2). The significance of B's being the transferee lies
inthe fact that it will be B'r parent, A, who will be the deemed transferor, even though the
taxable termination may be postponed until the death of C, assuming C survives B.
185. Id.
186. See supra notes 64-66 and accompanying text.
187. I.R.C. § 2613(c)(3) (1976).
188. Id. § 2613(d)(1).
1981]
ESTATE PLANNING
beneficial enjoyment of the corpus or income of the trust."18i 9
The proposed regulations do not elaborate on these definitions. These regulations, however, do distinguish between present
and future interests and restricted and unrestricted interests and
powers:
A beneficiary's interest or power is a present interest or
power if the beneficiary has an unrestricted right to receive
corpus or income from the trust. A right is restricted if it is
contingent upon the happening of an event which is wholly
outside the beneficiary's control. A right to receive income or
corpus is unrestricted if the right would be enforceable under
governing local law, or if the right to receive income or corpus
or both is subject only to the giving of notice. If a beneficiary
may currently receive income or corpus upon the exercise of a
trustee's or other person's discretion, the interest may be a nominal interest .... 90
The Commissioner illustrates the distinction between present and
future interests with a simple example. "Assume a grantor creates
a. . . [GST. Under the terms of the trust instrument the current
income may be paid to the grantor's child A for life, or accumulated for the benefit of other [YGB's] at A's death."'' On these
facts, A has a present interest, and the other YGB's have future
interests. 192
A more complicated example illustrates the nature of the interests under the Uniform Gift to Minors Act. 19 "A transfers
$1,000,000 to his grandchild B, a minor, under the Uniform Gift
to Minors Act and names C, an unrelated party, the custodian.
All the income is accumulated until B reaches the age of majority.' 1 94 If no portion of the gift is used to discharge their obligation of support, B'sparents have afuture interest.19 5 Thus, when B
attains majority, there is no taxable termination. 9 6 If any portion
of the gift is used to discharge B's parents' legal obligation of support, however, 197 the parents' have a present interest, and there
189.
190.
191.
192.
193.
194.
195.
Id. § 2613(d)(2).
Prop. Treas. Reg. § 26.2613-4(d), 46 Fed. Reg. at 128.
Id. § 26.2613-4(e), example (1).
Id.
UNiF. GIFT TO MINORS AcT, 8 U.L.A. 181 (1972).
Prop. Treas. Reg. § 26.2613-4(e), example (3).
Id.
196. Id.
197. Id. "If upon the exercise of a power by a trustee or custodian, an individual is
relieved of any legal obligation, that individual's interest becomes a present interest." Id.
§ 26.2613-4(d).
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
will be a taxable termination when B becomes an adult.19 8
The remaining example in the regulations illustrates how a
beneficiary may have both an interest and apower. "G creates a
[GST]. Under the terms of the trust instrument, the income is
payable to G's children for their joint lives with the last surviving
child having a nongeneral testamentary power of appointment
over the trust assets. The last surviving child has a present interest
and a future power."' 199 The persons who could benefit from the
exercise of
the power are all beneficiaries having no present
°
2°
interest.
The test for determining when a power is a present power
causing a taxable termination on its lapse or exercise is whether
"the property subject to the power would have been included in
the estate of the power holder under section 2036 or 2038 had the
power holder been settlor of the trust."' 20 1 This regulation imports
the extensive case law regarding a trustee's powers under sections
2036 and 2038 into the law of generation-skipping transfers.2 "2
The statute, however, is concerned only with beneficial, and not
198. Id. § 26.2613-4(e), example 3. The commissioner's example appears to be an unwarranted extension of the law. First, an accumulation during the minor's minority is
treated as a gift of a future interest to theparent. Under traditional federal gift tax analysis,
this accumulation has been treated as a gift of a future interest to the minor, and it would
fail to qualify for the $10,000 gift tax exclusion, unless expressly made to qualify under
I.R.C. § 2503(c) or possibly a Crummey trust under I.R.C. § 2503(b). See infra note 286
and accompanying text. Planners choosing this route risk the Commissioner's treating the
entire arrangement as the equivalent of a trust for theparent's benefit during the minor's
minority.
199. Prop. Treas. Reg. § 26.2613-4(e), example (2), 46 Fed. Reg. at 128.
200. Id.
201. Id. § 26.2613-4(d).
202. See, e.g., Helvering v. City Bank Farmers Trust Co., 296 U.S. 85, 92, reh'g denied,
296 U.S. 664 (1935), where the Supreme Court held that property transferred subject to a
power of revocation exercisable by one of the beneficiaries required inclusion in gross estate under § 302 of the Revenue Act of 1926 (I.R.C. § 2038(a)(1) (1976)). Section 2038
applies to powers over enjoyment of the transferred property, and § 2036(a)(2) applies to
powers of possession or enjoyment of the property and income.
The introduction of §§ 2036 and 2038 into the GSTT substantially broadens the scope
of the statute. Under these concepts, the retention by the settlor of the power to alter the
time or manner of enjoyment of the trust property or income would cause the assets of an
inter vivos trust to be included in the settloer's gross estate. The commissioner would extend
the effects of these powers, for purposes of the GSTT, to trustees generally. The taxpayer
would have the burden of showing that the trustee was independent and not "related or
subordinate." I.R.C. § 2613(e)(2)(ii) (1976). See Prop. Treas. Reg. § 26.2613-7(a)(2), 46
Fed. Reg. at 129.
This definition is more extensive than the similar definition for income tax purposes.
Compare I.R.C. § 2613(e)(2)(B) (1976) (defining "related or subordinate trustee" for purposes of the GSTT) with id. § 672(c) (defining "related or subordinate party" for purposes
of the income tax on trust income).
ESTATE PLNNING
fiduciary, powers. 203
The value of a power for purposes of a taxable termination is
the value of the trust property subject to the power, determined as
of the termination date .2°1 This valuation is proper, even though
the power is subject to an ascertainable external standard. °5 The
valuation also is proper when the beneficiary holds a "five-andfive" power. Assume the value of the principal of a trust is
$100,000 and the beneficiary may withdraw annually five percent
of the trust corpus2° 6 or five thousand dollars, whichever is
greater. The value both of the property and the power is still
$100,000 "regardless of the number of years for which the power
was held, exercised or allowed to lapse and regardless of the aver' 20 7
age value of the trust during the period the power was held."
The annual lapse of a general power that is not taxable under
the federal estate and gift taxes is not a taxable event under the
GSTT.2 11 The release, final lapse, or exercise of the power, however, may be a taxable termination.209 When a power is exercisable only over a portion of the trust property, just that portion is
considered in valuing the property.210
2. The Exceptions
The Code provides two specific exceptions for certain powers
held by third parties having no beneficial interest in the trust. The
first exception concerns those having no present future power in
the trust "other than a power to dispose of the corpus of the trust
or the income therefrom to a beneficiary or a class of beneficiaries
who are lineal descendants of the grantor assigned to a generation
younger than the generation assignment of such individual." 211
This power provides a degree of flexibility for the estate planner
203. Cf. Old Colony Trust Co. v. United States, 423 F.2d 601 (1st Cir. 1970) (estate of
settlor-trustee charged with value of principal where inter vivos trust instrument gave
trustee the discretion to decrease or cease income payments to life beneficiary, a son of
settlor-trustee).
204. Prop. Treas. Reg. § 26.2613-3(b)(1), 46 Fed. Reg. at 126-27.
205. Id. § 26.2613-2(b)(3)(ii), 46 Fed. Reg. at 125. It is assumed that the beneficiary's
needs are "not so remote as to be negligible ....
.. Id.; see also STAFF EXPLANATION,
supra note 74, at 574.
206.
207.
208.
209.
210.
211.
at 129.
Prop. Treas. Reg. § 26.2613-3(b)(1), 46 Fed. Reg. at 126.
Id. See also STAFF EXPLANATiO N, supra note 74, at 574.
Prop. Treas. Reg. § 26.2613-3(b)(1), 46 Fed. Reg. at 126.
Id.
Id. § 26.2613-3(b)(2).
I.R.C. § 2613(e)(1) (1976). Seealso Prop. Treas. Reg. § 26.2613-6(a), 46 Fed. Reg.
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
desiring to place a power in a person having no other interest in
the trust. This provision is illustrated in the following example.
Grantor, G, establishes a GST with the income payable to a GC
for life. At the death of GC, the trustee is to distribute the principal to such persons as G's child, C, appoints from among the lineal descendants of G who are assignedto the generation of GC or
any younger generation. C appoints the remainder interest to
GGC. C dies. There is no taxable termination at C's death by
virtue of C's power over the trust property. When GC dies, there
is a taxable termination due to the termination of GC's interest in
the trust. If the drafter provides that C can appoint the right to
receive principal to the lineal descendants of G, there is a taxable
termination at C's death since C could have appointed to his or
her own generation.
When the GSTT was first enacied, there was no provision affording independent trustees an exception from the rules. Such
trustees often have a sprinkling or spray power to distribute trust
income and principal to beneficiaries. This omission was corrected with the addition of section 2613(e)(2) to the Code.21 2
Under the Code and regulations, a trustee is deemed to have
no power in the trust if such individual has no interest in the
trust,2 13 is not "related or subordinate" to the grantor or any beneficiary of the trust, 21 4 and possesses no present or future power in
the trust other than a spray or sprinkling power to dispose of the
corpus or income of the trust for the benefit of beneficiaries designated in the instrument.215
A number of relationships, similar to those in the "related or
subordinate party" classification for purposes of taxation of trust
or
income to the settlor, 216 cause a trustee to be deemed "related 217
spouse;
of
those
are
relationships
these
Among
subordinate."
father, mother, lineal descendant, brother, or sister;218 employee
212. Revenue Act of 1978, Pub. L. No. 95-600, § 702(n)(3), 92 Stat. 2763, 2935.
213. I.R.C. § 2613(e)(2)(A)(i) (Supp. III 1979). See also Prop. Treas. Reg. § 26.26137(a)(1), 46 Fed. Reg. at 129.
214. I.R.C. § 2613(e)(2)(A)(ii) (Supp. III 1979). See also Prop. Treas. Reg. § 26.2613-7
(a)(2), 46 Fed. Reg. at 129.
215. I.R.C. § 2613(e)(2)(A)(iii) (Supp. III 1979). See also Prop. Treas. Reg. § 26.2613-7
(a)(3), 46 Fed. Reg. at 129.
216. See I.R.C. § 672(c) (1976). A related or subordinate party is presumed to be subservient to the grantor unless otherwise shown not to be by a preponderance of the evidence. Id.
217. I.R.C. § 2613(e)(2)(B)(i) (Supp. III 1979).
218. Id. § 2613(e)(2)(B)(ii). The regulation has added "employee" of the beneficiary to
this list. Prop. Treas. Reg. § 26.2613-7(b)(1), 46 Fed. Reg. at 129.
1981]
ESTATE PLANNING
of a corporation "in which the stockholdings of the grantor, the
trust, and the beneficiaries of the trust are significant from the
viewpoint of voting control"; 2 19 employee of a corporation "in
which the grantor or any beneficiary of the trust is an executive"; 0 partner of a partnership "in which the interest of the
grantor, the trust, and the beneficiaries of the trust are [sic] significant from the viewpoint of operating control or distributive share
which
of partnership income"; 22 1 or employee of a partnership "in
222
partner.
a
is
trust
the
of
beneficiary
any
or
the grantor
A trustee is not deemed to have a power in a trust "merely
because one or more of the potential appointees under a power of
appointment held by another is the trustee's spouse, father,
mother, brother or sister." 223 The Commissioner illustrates this
rule with the following example:
Assume grantor A creates a trust for the benefit of A's children B and C for their joint lives and for the life of the survivor. Upon the death of the survivor, the corpus is payable to
A's great-grandchildren if B fails to exercise his nongeneral
appointment.... A appointed A's close friend G as
power of
224
trustee.
On these facts, G has no power, although the trustee's spouse is a
potential appointee. 2'
H. CalculationandAdministration of the GSYT
The proposed regulations issued under section 2611 through
2613 of the Code constitute the substantive law of the GSTT. The
procedural law is articulated in temporary regulations. 26 These
regulations are based on Code sections concerning the imposi219. LR.C. § 2613(e)(2)(B)(iii) (Supp. II 1979).
Stockholdings in a corporation are significant if they provide effective control of the corporation. Prop. Treas. Reg. § 26.2613-7(b)(2), 46 Fed. Reg. at 129. Effective control ii defined as "the power to direct or cause the direction of the management and policies of the
corporation." Id.
220. LR.C. § 2613(e)(2)(B)(iv), (vi) (Supp. m 1979).
221. Id. § 2613(e)(2)(B)(v). A partnership interest is considered significant if at least
five percent of the partnership is owned by the grantor, the trust, or beneficiaries of the
trust. Prop. Treas. Reg. § 26.2613-7(b)(1), 46 Fed. Reg. at 129.
222. I.R.C. § 2613(e)(2)(B)(vii) (Supp. 111 1979).
223. Prop. Treas. Reg. § 26.2613-7(b)(3), 46 Fed. Reg. at 129.
224. Id. § 26.2613-7(c).
225. Id.
226. Temporary Generation-Skipping Transfer Tax Regulations under the Tax Reform Act, 26 C.F.R. § 26a.2621 (1981). Throughout this Article, all cites to the temporary
regulations will be designated Temp. Reg.
CASE WESTERN RESER VE LAW REVIEW
[Vol. 32:105
tion 2 7 and administration of the tax.uus
1. Method of Calculation
Section 2601 is a structural statute imposing the GSTT on
"every generation-skipping transfer in the amount determined
under Section 2602." 229 According to its legislative history, the
GSTT:
would be substantially equivalent to the estate or gift tax which
would have been imposed if the property had actually been
transferred outright to each generation. This is achieved by adding the amount subject to tax as the result of the generationskipping transfer to the other taxable transfers of the "deemed
transferor." The net effect is that the generation-skipping
transfer is230 taxed at the marginal rate of the deemed
transferor.
A tentative tax is computed on the total of the deemed transferor's
(1) taxable gifts made previously,2 3 1 (2) taxable estate, 23 2 (3) prior
generation-skipping transfers,2 33 and (4) current transfer.2 34 Subtracted from the total is a tentative tax on the first three of these
items.23 5
The result is the GSTT at the deemed transferor's marginal tax
rate.
2. Payment of the Tax
In the GSTT statutory scheme, the taxation of taxable distributions is analogous to the imposition of the gift tax. The recipient, however, pays the GSTT, while the donor pays the gift tax." 6
If the transferor pays the tax on behalf of the transferee, the latter
receives an additional taxable distribution.2 37 Funds used by the
grantor to pay the gift tax are never subject to any transfer tax." 8
The analogy of the taxation of taxable terminations to the estate
227.
228.
229.
230.
231.
I.R.C. §§ 2601-2603 (1976).
Id.§§ 2621-2622.
Id. § 2601.
232.
233.
234.
235.
236.
237.
Id. § 2602(a)(1)(D).
Id. § 2602(a)(1)(B).
Id. § 2602(a)(1)(A).
Id. § 2602(a)(2).
Id. § 2603(a)(1)(B).
Prop. Treas. Reg. § 26.2613-1(e), 46 Fed. Reg. at 124.
STAFF EXPLANATION, supra note 74, at 575.
I.R.C. § 2602(a)(1)(C) (1976).
238. With inter vivos transfers includable in the gross estate under §§ 2036, 2037, 2038,
2041, and 2042 occurring within three years of death, the gift tax is "grossed up," iesulting
in the inclusion of both the transfer and gift tax in the gross estate. I.R.C. § 2035(c) (1976
1981]
ESTATE PLANNING
tax is even closer. Both taxes are paid out of the property, and the
tax is imposed on the transferor. 2 9 One difference is that under
the estate tax, the transferor is either the owner or his or her near
equivalent of the property, while the deemed transferor of the
GSTT does not purport to be the owner of any of the property.
The distributee remains personally liable up to the fair market
value of the property transferred 2" "until the'tax is paid in full or
becomes unenforceable by reason of lapse of time." 241 This potential liability exists whether the property received by the distributee results from a taxable distribution or taxable termination. To
file a proper return 42 and pay the tax2 43 on taxable terminations,
the trustee needs certain information regarding the deemed transferor's tax history.2' If the taxable termination occurs on the
deemed transferor's death, the trustee may obtain the necessary
information from the deemed transferor's personal representative.
The distributee also needs the tax history of the deemed transferor
to file a proper GSTT return on any taxable distribution. The
trustee obtains the necessary information from the Internal Revenue Service and is exempted from personal liability if the service
furnishes erroneous tax rates. 245 The staff explanation acknowledges the right of any person required to file a GSTT return to
obtain all information from the Internal Revenue Service neces246
sary "to properly prepare the return (or any refund claim)."
The distributee(s) and trustee must file the GSTT return on
& Supp. I 1979). In addition, the fair market value of any appreciation between time of
transfer and death is subject to the transfer tax system. Id. § 2035(a) (1976).
239. Id. §§ 2603(a)(1)(A), 2621(c)(1)(A)(ii).
240. Id. § 2603(a)(3).
241. Id. § 2603(b).
242. Id. § 2621(c)(1)(A)(ii).
243. Id. § 2603(a)(1)(A).
244. Id. § 2603(a)(2)(A). The trustee is not liable for any additional tax attributabe to
tax rates above those furnished by the Internal Revenue Service, "as. . .the rates at which
the transfer may reasonably be expected to be taxed." Id.
245. Id.
246. STAFF EXPLANATION, supra note 74, at 581.
The Temporary Regulations specify the items which a trustee or distributee may request to
get the necessary information to complete the tax return, Form 706-B:
(i) The amount of the deemed transferor's adjusted taxable gifts within the meaning of section 2001(b) as modified by section 2001(e),
(ii) The amount of the deemed transferor's taxable estate and the estate tax
thereon before allowance of any credits,
(iii) The amount ofprior generation-skipping transfers with respect to the deemed
transferor,
(iv) The amount of prior generation-skipping transfers that occurred within three
years prior to the deemed transferor's death and the amount of the generationskipping tax paid with respect to these transfers,
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
taxable distributions and taxable terminations for any trust.2 4 7
Since a GST equivalent has no trustee, the distributee must file
the return.2 48 When an entity is the distributee, the duty to file the
GSTT return falls on those individuals deemed the beneficiaries
for purposes of the ascertainment of generations.2 49 A fiduciary or
agent must file the return for a minor,25 0 an incompetent, 25 1 a disabled person,25 2 or deceased distributees 3
When there are two or more distributees, the GSTT is prorated among them in proportion to the fair market values of their
respective interests.2 5 4 If one or more distributees fail to join in
the filing of the return, the remaining distributee(s) must file for
the whole transfer and recover any tax attributable to the nonfiling distributees. 255 For taxable terminations, only one trustee files
57
the return, 256 but all trustees must be notified.
(v) The amount of generation-skipping transfer tax imposed before the allowance
of any credits with respect to prior generation-skipping transfers,
(vi) The amount of State death tax credit allowed on the deemed transferor's
estate tax return and the amount of State death tax credit allowed on prior generation-skipping transfer tax returns,
(vii) The amounts necessary to complete Schedule F, Credit for Tax on Prior
Transfers,
(viii) The amount of the grandchild exclusion that has been used for transfers to
a grandchild of the grantor,
(ix) The amount of any taxable distributions or taxable terminations that occurred during the same taxable year and that were made from other trusts having
the same deemed transferor, and
(x) Any other data that may be needed to complete Form 706-B, GenerationSkioping Transfers Tax Return.
Temp. Reg. 26 C.F.R. § 26a.2621-1(J) (1981).
247. Temp Reg., 26 C.F.R. § 26a.2621-1(b)(1)(i), (ii) (1981).
248. Id. § 26a.2621-1(b)(1)(iii).
249. Id. § 26a.2621-1(b)(2). See I.R.C. § 261 1(c)(7) (1976) (determination of deemed
beneficiaries where entity is distributee).
250. Temp. Reg., 26 C.F.R. § 26a.2621-1(b)(3)(i) (1981). The fiduciary is the minor's
guardian or other person charged with the care of the minor's person or property. Id.
251. Id. § 26a.2621-1(b)(3)(iii). The fiduciary is "the guardian or committee of an insane person." Id.
252. Id. § 26a.2621-1(b)(3)(ii). An agent may file a return for those unable to do so
due to disease, injury, illness, or absence from the country. "IT]he return must be ratified
by the principal within a reasonable time after such person becomes able to do so." Id.
253. Id. § 26a.2621-b(3)(iii). The fiduciary is "the executor or other person in possession of the decedent's [the distributee's] assets.
... Id.
254. Id. § 26a.2621-1(b)(4)(i), (h)(i).
255. Id. § 26a.2621-1(b)(4)(i).
256. Id. § 26a.2621-1(b)(4)(ii).
257. Id The trustee or trustees are "personally liable for the tax imposed on the transfer if the tax is not paid when due." Id. § 26a.2621-1(h)(2).
For purposes of filing a return, the trustee is required to prepare two forms for taxable
distributions: (1) Form 706-B(l) (Information Return by Trustee for a Taxable Distribution or Termination from a Generation-Skipping Trust); and (2) Form 706-B(2) (Beneficiary's Share of a Taxable Distribution from a Generation-Skipping Trust). Id. § 26a.
ESTATE PL.ANNING
I. Certain Tranyfers Within Three Years of Death
Section 2035 provides that certain transfers during the three-
year period prior to a decedent's death are included in the gross
estate." In addition, the amount of gift tax paid on these transfers is "grossed up" and included in the decedent's gross estate. 9
The GSTT follows these principles by imposing a tax "determined
as if the transfer occurred after the death of the deemed transferor."2 6 0 As a result of taxing the GST at the deemed transferor's
death, the amount of tax imposed is increased. This increase ex-
ists especially in an inflationary period since the appreciation between time of transfer and time of death, plus the amount of
transfer tax paid are all subject to the transfer tax. The temporary.
regulations solve this problem and provide a method for handling
the problem of amending a GSTT return when the deemed trans-
feror has made a generation-skipping transfer falling within section 2602(e). In such a case, "[t]he due date for the return is
determined as if the prior transfer occurred at the same time as the
deemed transferor's death and the tax must be recomputed as if
the transfer had occurred immediately after the deemed transferor's death. 2 6 1
2621-1(0(1). The first form is filed with the Internal Revenue Service Center, where the'
distributee will later file Form 706-B. Id. Form 706-B(2) must be sent by the trustee to the
beneficiary within the time that the trustee is required to fie Form 706-B(l). Id. The
distributee(s) then prepares his or her Form 706-B based on the information received from
the trustee. Only one Form 706-B is required to be filed by two or more YGB's having the
same deemed transferor. Id.
When the deemed transferor is living, the filing date for Form 706-B(1) is the "fifteenth
day of the third month following the close of the taxable year of the trust," or March 15 for
a trust on the calendar year. Id. § 26a.2621-1(f)(2). Six months after the close of the trust's
tax year, June 30, for a trust on the calendar year, the distributee(s) or the trustee must file
Form 706-B for any taxable distributions or terminations that occurred during the tax year.
Id. § 26a.2621-1(c)(1). "In the case of a taxable distribution or termination that occurs
within the same taxable year as the death of the deemed transferor, or any time after the
death of the deemed transferor," the due date for Form 706-B is the later of six months
after the close of the trustee's taxable year or six months after the federal estate tax return
of the deemed transferor is due. Id. If there is a postponement of a taxable termination,
the due date for filing the returns is measured "from the date on which the transfer is
deemed to occur," rather than the date of the actual transfer. Id.
258. LR.C. § 2035(a) (1976). See spra note 238.
259. Id. § 2035(c).
260. Id. § 2602(e). Additional adjustments for any prior GST or taxable gifts of the
deemed transferor must be made. See id. § 2602(a)(10)(B), (C). See also supra note 231
and accompanying text.
261. Temp. Reg., 26 C.F.R. § 26a.2621-1(c)(2) (1981).
CASE WESTERN RESERVE LAW REVIEW
IV.
ESTATE PLANNING AND THE
o 32:105
[Vol.
GSTT
With the enactment of ERTA, questions arise as to the extent
to which estate planning principles have been modified and, more
particularly, how the planner should integrate the GSTT with respect to these principles. Three estate and gift tax changes are
especially interesting to the estate planner: the unlimited marital
deduction,26 2 the new gift tax exclusions,2 6 3 and the new treatment
of gifts made within three years of death." u The greatest single
change is that the planner no longer is required to limit the size of
the deduction to the greater of $250,000 or one-half of the adjusted gross estate.2 65 In addition, community property now qualifies for the deduction,26 6 and the planner is free to depart from
the familiar pattern of giving S2, the surviving spouse, a general
67
power of appointment to qualify for the marital trust deduction.
As a result, the planner has much flexibility in developing plans,
and the distinction between estate plans in community property
and common law states is all but eliminated. 68
Effective estate planning requires the planner to coordinate
both tax and nontax objectives. To effect these dual goals, the
planner must make several inquiries. The planner must determine whether S2 already has substantial property and must formulate the plans to be made in the event that S2 predeceases S1,
the spouse owning the bulk of the family's wealth. The planner
also must decide whether an attempt should be made to equalize
the size of the estates of both S, and S2. Regarding control over
the estate plan, the planner must exercise judgment about the importance of Sl's retention of control and should ask whether S2 is
to maintain as much control as possible after SI's death. With
reference to taxation, the planner must ask whether the primary
tax objective of S, and S2 is to defer payment of transfer taxes as
long as possible, regardless of the amount.
262. See supra note 11.
263. See supra notes 91-92 & 144-53 and accompanying text.
264. See supra notes 258-61 and accompanying text.
265. Congress achieved this result by repealing I.R.C. § 2056(c) (1976). ERTA
§ 403(a)(1)(A).
266. ERTA § 403(c).
267. See I.R.C. § 2040(b)(2) (1976).
268. The planner in a common law state, for example, may make a tax-free interspousal transfer from S, to $2, so that the two estates are equalized. See I.R.C. § 2523
(1976). Alternatively, the planner may elect to use the new "qualified terminable interest"
election under Code § 2056(b)(7). ERTA § 403(d)(1). The planner in the community
property state has similar options and can adjust differences between the estates of S l and
S 2, or use the qualified terminable interest election.
ESTATE PL.NNING
Other questions for the planner include whether a charitable
remainder plan 69 in S2 is desirable if S I and S2 are childless;
whether S1 and S2 have a plan to make inter vivos gifts, or whether
a gift program should be established; whether property should be
retained until death to take advantage of a stepped-up basis; and,
the way in which the estate plan should be coordinated to obtain
optimal advantage from both S1's and S2 's unified credits.
In planning the disposition of SI's estate to obtain the most
favorable transfer tax situation, the planner has three basic
choices. The first choice (plan A) transfers SI's entire estate to S2
through outright gift to S2, gift of life estate with general power of
appointment to S2, or gift of life estate to S2 , remainder to S2's
estate (the so-called "estate trust"). The second choice (plan B)
establishes a "Q-TIP" trust"7 0 for S2 under new section 2056(b)(7)
and elects to defer the taxation of the family's wealth accumulation until the death of S2, or until S 2 disposes of the life interest,
whichever event occurs first. The third choice (plan C) provides
that aportion of S2's estate go to the next generation and that the
balance go to S2 , under plan A or B. This portion is measured by
the amount necessary to gain optimal benefit of the unified credit
(plan C-1); or, alternatively, S 2 is given roughly one-half of S,'s
property to equalize the two estates (plan C-2).
Under plan A, there is no tax upon Sl's death, but S, will have
to pay a substantial tax to pass the property to the next generation,
thereby leaving less for the next generation. Historically, Plan B
was considered "under-qualification." Prior to the introduction of
the marital deduction, a large tax would be paid at SI's death but
there would be no tax at S2's later death when the remainder
vested in the next generation. St, however, could control the ultimate disposition of the property.2 7 1 By allowing S1 's personal representative to defer the tax until S2's later death, the new law
allows SI to retain control without the former adverse tax consequence. Plan C is a combination of the other two plans and seeks
to obtain the maximum tax benefit. Plan C necessarily will involve the drafting of a residuary clause in accordance with the
269. Under the new law, S, may give S2 a terminable interest followed by a remainder
to charity under a qualified charitable remainder trust, and both interests will be fully
deductible. See ERTA § 403(d)(1).
270. See supra note 20.
271. 2 H. WRnN, CREAAvaE ESTATE PLANING § 12.01 (1970).
CASE WESTERN RESERVE L.W REVIEW
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present law.272
To appreciate the tax effects of these various estate plans, assume three different taxable estates of $1 million, $2 million, and
$5 million, respectively. Under Plan A, there is no tax upon SI's
death. At S2's later death, the taxes would be as follows:
At the $1 million level: $153,000
At the $2 million level: $588,000
At the $5 million level: $2,083,000
Under plan B, if S1's estate should elect to treat S2's life estate as a
"qualified terminable interest," the results would be the same. If
SI's executor does not elect to treat S2's life interest as a "qualified
terminable interest" under section 2056(b)(7), however, S1's estate
will have to pay estate tax at SI's death.
Both plans A and B fall short of the optimum estate plan. The
principal advantage of these plans is that no tax is paid on SI's
death. All taxes in the generation of S, and S2 may be deferred
until the second death. The two plans, however, suggest some deficiencies: (1) no effort is made to take advantage of SI's unified
credit; (2) no effort is made to reduce the taxation levels of S, and
S 2 by taxing two estates at lower rates; and (3) any transfer tax
paid at SI's death will reduce correspondingly the amount available to be taxed at S2's later death. These deficiencies may be
corrected by passing some of S1's estate to the next generation, but
a question remains as to the quantity of the estate property to be
passed.
One solution (plan C-l) is to give the next generation the
equivalent of Si's exemption through the unified credit. Following this approach, by 1987, $600,000 could be passed to the next
generation at SI's death tax free. At S2's death the transfer tax
then would be:
272. An example of such a clause is:
I give to S2 an amount equal to the smallest amount that, if allowed as a
deduction in computing the federal estate tax liability of my estate, would reduce
such liability (after taking into account all credits allowed against such tax) to
zero, diminished by the value for such purposes of all other items in said gross
estate qualifyring for said deduction and passing to my wife under other provisions of this will or otherwise, all such values to be as finally determined for
federdal estate tax purposes.
If the drafter uses a fractional share formula, the first portion of the above clause will readI give to S2 that fraction of my residuary estate of which the numerator is the
smallest amount that,. . . [balance of the clause as above].
See generaly D. WsTFALL, ESTATE PLANeiNG 491 (1982).
ESTATE PLA4NNING
$1 million
level
$2 million
level
$5 million
level
$4,400,000
$1,400,000
$400,000
Taxable Estate
1,975,800
512,800
121,800
Taxable Estate Tax
192,800
192,800
192,800
Minus Unified Credit
$1,783,000
$320,000
$ -0Tax Payable
This solution does not take advantage of the elimination of some
tax from S2's estate by paying some estate tax at S,'s prior death,
but it does provide tax deferral. If S2's needs could be met at the
$2 and the $5 million levels by a gift of fifty percent of these
amounts at S 1's death, the total transfer tax cost to SI and S 2 could
be reduced further:
$5 million
$2 million
level
level
Gift to S2
$2,500,000
$1,000,000
(upon SI's death)
Gift to Next Generation
$1,667,000
$ 847,000
(upon SI's death)
$ 833,000
153,000
$
Tax upon SI's Death
$ 833,000
$ 153,000
Tax upon S2's Death
$1,666,000
$ 306,000
Total Transfer Taxes
In short, by paying some of the transfer taxes on the family unit
upon S's prior death, the planner may save substantial amounts:
Plan C-2
Plan C-1
Plans A-B
(50% to S2 )
($600,000 to
next generation)
$ -0$ -0$ 153,000
306,000
320,000
588,000
1,666,000
1,783,000
2,083,000
Tax Savings
Tax Savings
Between Plans A & B Between Plans A & B
and Plan C-2
and Plan C-I
$153,000
$153,000
$1 million level
282,000
268,000
$2 million level
417,000
300,000
$5 million level
These solutions have not necessarily resolved all problems facing
the planner. If, for example, S2 predeceases S1, and S owns all
the family property, the potential savings will disappear. An alternative plan would provide for a tax-free interspousal transfer
from S, to S2 of approximately one-half of SI's adjusted gross estate. The estates would then be roughly equal and the results described above would follow regardless of who dies first.
$1 million level
$2 million level
$5 million level
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
Moreover, since the estate of the first spouse to die could elect to
treat a transfer to the other for life as a "qualified terminable interest," the advantage of splitting the transfer tax between two estates is still available.
Another method for reducing the transfer tax burden on S,
and S2 is to establish a lifetime gift program to reduce the size of
their holdings and transfer portions of their estate for several
years preceding their deaths. If, for example, SI and S2 have three
children and establish a gift program transferring $20,000273 to
each child each year for a ten-year period, the results will be as
follows:
$1 million $2 million $5 million
level
level
level
Original Total Estate
$1,000,000 $2,000,000 $5,000,000
Minus Gifts Over Ten
600,000
600,000
600,000
Years ($60,000 per
year)
$ 400,000
$1,400,000
$4,400,000
Under this program, there are no federal transfer taxes at all at the
$1,000,000 level. At the $2 and $5 million levels, the results will
be:
$2 million level $5 million level
Gift to S2 at Sl 's Death
$700,000
$2,200,000
Gift to Next Generation
$663,000
$1,514,000
upon Sl's Death
Tax upon Sl's Death
37,000
686,000
Tax upon S2's Death
37,000
686,000
Total TransferTaxes
$ 74,000
$1,372,000
Tax savings at the $2 and $5 million levels are $514,000 and
$711,000, respectively.
Prior to 1982, any transfer by S, within three years of his or
her death was included in the gross estate. 274 Such a transfer was
subject to both gift and estate taxes, and a credit for any gift tax
paid was applied against the estate tax. The result was to tax the
gift's value at the time of transfer, plus any appreciation in value
between time of transfer and death. In addition, any gift tax paid
was "grossed up," so that this additional sum was subject to estate
273. I.R.C. § 2503(b) (1976). The transfers, of course, must not be gifts of future interests. Moreover, the general transfer of $20,000 to each donee presupposes that S2 will con-
sent to the appropriate gift splitting.
274. Id. § 2035(a), (d)(1).
ESTATE PL4NNING
tax.275 The net effect of the two transfer taxes was to place the
transferor in the same transfer tax position as a transferor who
retained the property until death.
ERTA retains the "gross up" feature for transfers within three
years of death, but limits the three-years-of-death rule to situations in which property would be includable under the inter vivos
transfer sections,27 6 the exercise of a general power of appointment,2 77 or the transfer of life insurance.278 While the appreciation between time of transfer and death is not subject to the
transfer tax system as to all other transfers, this appreciation is
subject to income tax in the hands of the transferee upon ultimate
disposition of the property.2 79 As a result, the planner will seek to
use "high basis" property for any transfer by gift.
To illustrate the problems of coordinating the GSTT with the
new ERTA rules, assume that (1) S and S2 make no inter vivos
gifts; (2) the bulk of the family's wealth is approximately
$2,000,000 and owned by SI; (3) S, and S2 have three children; (4)
each child has two children; and (5) there is a likelihood that S,
will predecease S2 . Assume further, that S1 desires to retain control over the estate and obtain maximum tax advantages. The
planner might suggest that approximately $600,000 be transferred
to the three children at SI's death, and that the tax burden be
borne entirely by this portion of the estate, so to relieve S2 from all
transfer tax responsibility. The planner also might recommend
the use of a Q-TIP trust to defer estate taxation until S2's death,
such trust giving S2 a life estate, with remainder over to the
grandchildren. The estate planner also might want to take advantage of the $250,000 exclusion upon the deaths of each of the three
children, with remainders over the grandchildren of S, and S 2.
Assuming S, is the husband, his will might read:
I give my estate to my trustee, the X Trust Company, in trust,
on the following conditions: (1) My trustee shall hold in trust
for the lives of my three children, A, B, and C, and the life of
the survivor, property of a fair market value, as determined for
federal estate tax purposes, equal to the exemption equivalent
for purposes of the unified credit of the federal estate tax in
force at the time of my death; and at the date of the death of the
275.
276.
277.
278.
Id.
Id.
Id.
Id.
§ 2035(c).
§§ 2036-2038.
§ 2041.
§ 2042.
279. The transferees basis normally will equal the basis of the transferor, increased by
any gift tax paid with respect to the transfer. Id. § 1015.
CASE WESTERN RESERVE LAW REVIEW
[
[Vol.
32:105
last survivor of my three children, my trustee shall distribute
the principal and any accumulated income from the said trust
to the children of A, B, and C, living at the death of the last
survivor thereof. This trust shall be known as the "Husband
Family Trust."
(2) My trustee shall hold the balance of my residuary estate in
trust for my wife for her natural life, and at her death distribute
the principal of this portion of my estate to my grandchildren,
per capita, living at the death of my wife, in equal shares. If
any one or more of my grandchildren shall be under age eighteen at the death of my wife, I direct that his or her share shall
be held in trust until he or she shall reach age eighteen, at
which time my trustee shall distribute the principal and any
accumulated income for his or her share to him or her. This
trust shall be known as the "Wife Grandchildren Trust."
(3) I authorize my executor to elect to treat the life interest in
my estate which I have given to my wife as a qualified terminable interest under the Internal Revenue Code.
Assuming the husband S, dies in 1987, or thereafter, this estate
plan eliminates the transfer tax at Sl's death since the Husband
Family Trust is covered by the unified credit.2"' At the wife's
death, the gross estate equals $1,400,000 with an estate tax of
$320,000, leaving a balance of $1,080,000 for distribution to the
grandchildren at that time. Since S, and S2 are of the same generation, S is not a younger generation beneficiary (YGB), and the
Wife Grandchildren Trust is not a GST. 28 1 The "Husband Famfly Trust" is a GST. On the death of the last survivor, there is a
$250,000 exemption each for A, B, and C as deemed transferors
for as much as a twenty-five percent increase in the value of the
trust prior to its being distributed to the grandchildren.2 8 2
Moreover, through this estate plan, S1 accomplishes several
objectives. S transfers an estate of $2,000,000 to his children and
grandchildren at a cost of $320,000, or a net transfer of $1,680,000.
At an annual return of six percent on $1,400,000, S, provides S2
with an annual income for life of $84,000,283 and provides the
children an income of $12,000 per year for their lives. In addition,
S, makes it possible for his grandchildren to assume an inheritance of $280,000.
S, can vary these results, depending on family needs. If, for
280. See supra note 2.
281. See supra notes 21-28 & 36-40.
282. This problem assumes constant values. The planner, however, may plan deliberately for appreciation or depreciation values.
283. This assumes a rate of return on the Wife Grandchildren Trust of six percent per
annum.
ESTATE PLANNING
example, the income amounts provided A, B, and C ($12,000 each
per year) are insufficient, S, can give more to the children and less
to S2 . This procedure increases the size of the Husband Family
Trust without increasing the GSTT on the death of the survivor of
A, B, and C.2 8 4 S1 can increase the trust for A, B, and C to a total
of $750,000. This addition would allow an increase in the children's annual income to approximately $15,000 at a federal estate
tax cost of $94,500. S1 would have to consider whether this immediate tax cost is worth the relatively small increase in annual income to his children.
Under ERTA, S, may make a tax-free inter vivos transfer" 5 of
one-half of the estate to S2 . The principal advantage of such a
move is its protection against the possibility of losing the marital
deduction in the event S, should predecease S2 . S, and S2 now
may establish separate GST's, for A, B, and C, utilizing the
$250,000 exclusions for both of them with respect to each of their
three children.2 86
The planner may want to recommend one or more tax-free
interspousal transfers. If S, is willing to give S2 control of onehalf of the estate, both SI's and S 2's will can be drawn to take
advantage of the qualified terminable interest rule, thereby eliminating the risk of failure of the estate plan due to SI's unforeseen
death. At the $2,000,000 level, one-half or $1,000,000 is transferred tax-free to St. S's will provides that if S2 survives, the
$1,000,000 estate shall be placed in trust to pay the income to S2
for life with remainders over to the children and grandchildren. If
S, predeceases S 2, the property is to be placed in trust for the children and grandchildren.
S2's will is similar to Si's in that it provides that if S, survives
S2, S2 will take a life estate in S , with remainders over to the
children and grandchildren. If S, should fail to survive S2, S2 's
estate passes directly to the children and grandchildren. The ef284. If D dies on or after January 1, 1987, the estate has to pay a federal estate tax of
$94,500. Assuming that this tax is borne by the Husband Family Trust, A, B, and C each
receive one-third of the balance, $850,000 minus $94,500, or $755,500. This amount is
taxed slightly at the death of the survivor of A, B, and C, since it is almost entirely covered
by three $250,000 exclusions for them as deemed transferors.
285. I.R.C. § 2523(a) (1976).
286. Transfers to a grandchild of thegrantor are not treated as taxable terminations or
taxable distributions except to the extent that the total amount of the transfers from one or
more trusts exceeds $250,000 for each deemed transferor. Since S, and S2 presumably are
treated as separate grantors, the effect is to double the exclusions available for A, B, and C.
This increase in exclusions, however, is consistent with the fundamental philosophy of
community property, the unlimited marital deduction, and the concept of gift splitting.
CASE WESTERN RESERVE LAW REVIEW
[Vol. :32:105
fect of this plan is to transfer a net of $1,694,000 on a $2,000,000
estate to succeeding generations. Of this amount, $750,000 can
pass from the children to the grandchildren through a GST utilizing three $250,000 exemptions, and the balance ($944,000) can be
transferred directly to the grandchildren, thereby avoiding the
GSTT.
This plan, however, does not involve the establishment of separate trusts by both S and S 2. There is no reason why both cannot
be grantors of their separate estates. S, and S2 may want to act
separately and have each of their estates pass into a GST for the
children and grandchildren. Under such a plan, S, and S2 give
their estates in trust to A, B, and C for their lives, with remainders
over to the grandchildren. The planner also might utilize separate
shares in lieu of the Husband Family Trust discussed above. The
planner also might choose aper stirpes distribution to grandchildren in lieu of theper capita distribution. In this event, the total
tax cost and the value of the trusts created would be as follows:
SI's Estate ....................................... $1,000,000
Tax Thereon ....................................... 345,000
Minus Unified Credit ............................... 192,800
S1's Federal Estate Tax ........................... 153,000
Add S2's Federal Estate Tax ...................... 153,000
Total Tax Cost ................................. $ 306,000
SI's Trust for A,B, & C ($1,000,000 - $153,000) ... $ 847,000
S2's Trust for A,B, & C ($847,000 + $1,000,000 $153,000) ........................................ $1,694,000
At the death of the survivor of A, B, and C (or on their respective
deaths, if the separate share rule is utilized), there would be little
or no additional tax since the deemed transferor could utilize both
the $250,000 exclusions and their respective unified credits.
From the estate planning perspective, one of the most important changes in the ERTA is the increase in the section 2503 gift
exclusion from $3,000 to $10,000. The planner now can arrange
for the transmission of substantial amounts of property over a period of time, free of any transfer taxation, through the establishment of effective gift programs.
For most programs, the key to success lies in ascertaining that
any transfer to a donee is a transfer of apresent interest. To the
extent that the interest transferred to the transferee is a future interest, the deduction will be lost. In planning gifts to minors,
planners may elect to use the more flexible Crummey (section
1981]
ESTATE PLANNING
2503(b)) trusts2 87 in preference to section 2503(c) trusts. If the minor beneficiary has the right to demand the income from the trust,
the planner is assured that the gift is apresent interest.
"Trust equivalents" are rarely more desirable from aplanning
standpoint. More often than not, the "trust equivalent" is used
without the drafters' awareness of the GSTT problems. The Uni-
form Gifts to Minors Act288 inadventently may cause some arrangements to become subject to the GSTT. If the plan is not
used to discharge a parent's support obligation, however, the
GSTT should not be involved. Many life insurance arrangements
or life insurance and annuity combinations may be considered
"trust equivalents." To the extent that these equivalents are favored over the more usual living trust, the planner must be prepared to meet any adverse consequences which the GSTT might
present in future years.
V.
CONCLUSION
The purpose of this Article is to alert the estate planner to the
planning possibilities and tax traps of the GSTT, rather than to
explore the various tax policies underlying the transfer tax. The
GSTT has been criticized as being overly complex.2 8 9 Such a crit-
icism can be made of much, if not all, of the Internal Revenue
Code. The fundamental philosophy underlying the GSTT re-
mains sound. The primary pupose of transfer taxes in the United
States never has been to raise revenue. Instead, the purpose of
such taxes has been to prevent the unwarranted accumulation of
287. Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968). See also Rev. Rul.
73-405, 1973-2 C.B. 321. The Service allows a § 2503(b) exclusion, even though no guardian has been appointed, if neither the trust nor local law precludes a minor donee from
demanding distribution of the trust income. See Stifel v. Commissioner, 197 F.2d 107, 110
(2d Cir. 1952) (court disallowed exclusion where trust created for child gave trustee discretion to make payments of income to child's guardian).
288. UNIF. GiFr TO MiNoRs Acr, 8 U.L.A. 181 (1972).
289. Testifying before the Senate Finance Committee, Donald W. Thurmond, former
Chairman of the Trust Division, American Bankers Association, stated that the GSTT has
been described as "impossibly complex... a trap for the unwary .. . extremely costly to
administer and yet will raise little revenue." TRUST LErrR, Nov. 10, 1981, at 3. Mr. Thurmond noted that the proposed regulations fail to provide guidance on several issues, the
answers to which are required before even common types of trusts can be drafted properly.
The unworkability of the tax is illustrated by the failure of the Internal Revenue Service to
provide "a simple, relevant and timely set of forms." Id. The costs of administering the
tax would be monumental, since the IRS will become a national clearinghouse for transfer
tax information. Information will have to be stored for at least seventy-five years. In contrast with these costs, the GSTT will produce negligible revenue in its early years and only
$250 million annually in the long term. Id.
CASE WESTERN RESERVE LAW REVIEW
[Vol. 32:105
wealth. If the United States is to retain dynamism in its economy,
it is important that this policy be continued.
For the most part, the transfer tax system has worked well.
The original federal estate tax in 1916 sought to reach property in
which the decedent had an interest at death and inter vivos transfers "in contemplation of or intended to take effect in possession
or enjoyment at or after his death .. ."I" From the beginning,
Congress guarded against evasions of the fundamental policy of
the statute. Judicial interpretation of these phrases and their statutory successors, along with the addition of the gift tax in 1932,
combined to create a reasonably effective, but far from perfect,
transfer tax system.
In the post-War period, the American Law Institute and the
Treasury Department strove to perfect the system, with their efforts culminating in the Tax Reform Act of 1976.291 The GSTT
and carryover basis were the two principal changes introduced
into the overall tax system. Although Congress chose not to unify
the estate and gift taxes into a single transfer tax, certain aspects of
unification were introduced. Carryover basis eventually was repealed and the GSTT may now suffer the same fate. Before Congress repeals the tax, it should give serious thought to the entire
transfer tax system. Some think that the system should be abandoned entirely.2 92 Others would strengthen the entire transfer tax
structure by providing for a single transfer tax at each
generation.2 9 3
Presently, the GSTT does not pose a threat to the knowledgeable estate planner. The planner can lessen the tax's impact by using separate shares to avoid putting more than one generation of
YGB's in any trust, by deferring the tax for long periods, or by
skipping generations by making direct gifts to much younger
generations.
Although those who are aware of the tax can protect themselves through careful planning, the GSTT remains a trap for the
unwary. The proposed regulations on the substantive aspects of
the law are not only inadequate, but misleading. One example of
the Commissioner's effort to expand the statute's scope is the ex290. Revenue Act of 1916, ch. 463, § 202(b), 39 Stat. 773, 778 (repealed 1919). Although this provision has been revealed, its interpretation remains alive.
291. Pub. L. No. 94-455, 90 Stat. 1520 (1976) (codified in scattered sections of 26
U.S.C.).
292. Canada repealed the transfer tax system seven years ago. See also supra note 6.
293. See generally E. HALBACH, DEATH, TAXES AND FAMmY PROPERTY 77-100 (1977).
ESTATE PLANNING
tension of the role of the custodian under the Uniform Gifts to
Minors Act.2 94 The Commissioner has not sought to differentiate
the fundamental distinction between fiduciary and beneficial powers in this context. The Commissioner also has not related taxability in this area to the legal obligation of support. Another example
of the Commissioner's effort to expand the statute's scope is the
suggestion that the case law under sections 2036 and 2038 should
be imported into the interpretation of the GSTT. Like the custodian rules, the case law under sections 2036 and 2038 developed
around the concept of the retention of powers by the settlor. To
draw an analogy between the settlor of a trust who retains economic dominion and control, and a deemed transferor under the
GSTT, is patently erroneous.
By seeking to stretch the GSTT beyond its normal statutory
bounds, the Commissioner has placed the GSTT in jeopardy, particularly among those in Congress who would like to see the statute repealed. The Commissioner should have provided credible
examples of the operation of the tax well within its statutory limits. Perhaps the Treasury Department will be able to pursuade
Congress that the fundamental concept of the generation-skipping
transfer tax-that accumulations of wealth should be taxed once a
generation-is too important to be abandoned totally. With some
modifications, the tax may well be retained as part of a complete
transfer tax system. With adequate knowledge of the system, the
estate planner then will be able to serve clients more effectively.
294. UNi. GIFT TO MINORS Acr, 8 U.L.A. 181 (1972).